De-dollarisation & Hedging Against Dollar Reliance

Syllabus: GS3/Economy

Context

• Recently, the Reserve Bank of India (RBI) has clarified that its recent measures, such as allowing Vostro accounts and promoting trade in domestic currencies, are aimed at diversifying risk rather than pursuing outright ‘de-dollarisation’.

What is De-dollarization?

• It  describes a process of moving away from the world’s reliance on the U.S. dollar (USD) as the chief reserve currency.
• It refers to shrinking the influence that the U.S. dollar has on the economies of other countries.

Historical Context

• The U.S. dollar has been the world’s primary reserve currency since the Bretton Woods Agreement in 1944.
• It has provided the U.S. with significant economic advantages, including lower borrowing costs and greater influence over global financial systems.
• However, the dominance of the dollar has also led to concerns about its potential misuse as a tool of economic coercion.

Reasons For De-dollarisation

• Economic Sanctions: The imposition of US sanctions on countries like Russia and Iran has pushed them to seek alternatives to the US dollar to avoid economic isolation.
• Diversification of Risk: Nations are looking to reduce their dependence on the dollar to mitigate risks associated with fluctuations in US monetary policy.
  • It helps them maintain greater control over their own economic policies.
• Strength of the Dollar: A strong US dollar can lead to higher costs for imports and debt repayments in other countries, exacerbating economic challenges.
• Geopolitical Shifts: The rise of other major economies, such as China, has led to increased use of their currencies in international trade.
  • For instance, Russia and China conduct a significant portion of their trade in their national currencies.
• BRICS Initiatives: The BRICS nations have discussed the possibility of a shared currency to facilitate trade among member countries and reduce reliance on the dollar.

Why Not De-dollarisation?

• Geopolitical Considerations: The rise of the Chinese yuan as a potential challenger to the US dollar complicates the de-dollarisation narrative.
  • India is cautious about increasing its reliance on the yuan, especially given the geopolitical tensions with China.
• Economic Stability: The US dollar remains the most stable and widely accepted currency for international trade.
  • A sudden shift away from the dollar could disrupt trade and economic stability. The RBI’s approach is to de-risk rather than destabilize the economy.
• BRICS Dynamics: The geographical and economic diversity among BRICS nations poses significant challenges.
  • Unlike the Eurozone, BRICS countries do not have the same level of economic integration or geographical proximity.
• US Trade Relations: Recent threats from US President-elect Donald Trump to impose tariffs on BRICS countries if they reduce dollar reliance underscore the potential economic repercussions of de-dollarisation.
  • Maintaining a balanced approach helps India avoid such punitive measures.

Strategic Measures By India: Hedging Against Dollar Reliance

• India’s economy is significantly integrated into the global financial system, where the US dollar dominates.
  • It poses risks, especially during periods of dollar volatility or geopolitical tensions.
• Gold Purchases: The RBI has significantly increased its gold reserves, aligning with global trends among central banks to diversify away from a dollar-dominated system.
• Local Currency Trade Agreements: By promoting transactions in domestic currencies and allowing Vostro accounts and entering local currency trade agreements, the RBI aims to reduce the risks associated with dollar dependence without completely abandoning it.

Source: IE