Trunk Economics | August 27, 2024US rate cuts coming. Why should we give a damn? Let’s de-dollarize
“THE TIME HAS COME FOR policy to adjust,” US Federal Reserve chairman Jerome Powell told an annual symposium for central bankers on August 24. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
So, has Powell greenlit a potential rate cut as early as September 2024? Well, many analysts do think so. The ripples of any rate action in the US, of course, will coast across thousands of miles, India included.
The US dollar (sometimes even the Euro) constitutes a considerable proportion of global trade invoicing, irrespective of the countries involved in the trade, where prices are set in dollars.
A rate cut in the US, other things remaining the same, can trigger a capital flight towards emerging economies, such as India, as investors chase destinations that will deliver more bang for their buck. (The opposite happens when interest rates rise in the US as investors move money home, seeking greater returns).
The relationship—between the US monetary action and the rest of world—is, however. Deeper than just large slices of money flowing among global financial capitals. To a large extent, it has got to do with the high dependency on the US dollar, which is the world’s reserve currency by most means.
Most often, it is the US dollar (or sometimes the euro) that constitutes a considerable proportion of global trade invoicing, irrespective of the countries involved in the trade, where prices are set in dollars.
India’s crude reality
Sample this. As much as 86 percent of India’s imports are invoiced in dollars, while only 5 percent of its imports originate in the US. While China makes up 16 percent of India's imports these are mainly invoiced in dollars.
There is the need to lower the dependence on the dollar and internationalize the rupee. There are signs of this happening.
This has resulted in an oddity. The rupee price and volume of India’s imports from China depend more on the rupee-dollar exchange rate than the rupee-yuan exchange rate.
There is also the question of the oil import bill. Crude oil transactions are denominated in US dollars. India’s reliance on imported crude increased to a record 87.3 percent of domestic consumption in 2022-23, up from 85.5 percent in 2021-22. The resultant rise in dollar demand has weakened the rupee. A stronger dollar pushes up the landed cost of imported products—from fruits to gadgets to crude oil—fanning inflation at home. There is indeed, thus, a need to lower the dependence on the dollar and internationalize the rupee. And there are signs of this happening. Sample this.
Bilateral pacts
On July 11, 2023, Bangladesh and India launched a much-anticipated trade transaction in rupees. On July 15, 2023, the Reserve Bank of India (RBI) and the Central Bank of United Arab Emirates (CBUAE) inked a framework to promote the use of local currencies, i.e., the Indian rupee (INR) and the UAE dirham (AED) for cross-border transactions.
Sovereign digital currencies (SDCs) can potentially lower dollar dependency in several ways.
Countries can hold SDCs as reserves instead of the dollar, lowering a dependence on the greenback.
SDCs can, at least in theory, facilitate international transactions and direct currency exchange, bypassing the need for USD as an intermediary.
On July 16, 2023, during ministerial-level talks, Finance Minister Nirmala Sitharaman and her Indonesia counterpart Sri Mulyani Indrawati announced the launch of an Economic and Financial Dialogue between the two countries, including the possibility of using more local currency (for trade).
Brazil and South Africa may be next in line for India’s bilateral currency settlement plan as it aims to first convince smaller countries to accept transactions in rupees.
Clearly, India is seeking to ride on bilateral trade pacts to internationalise the rupee and reduce dependency on the dollar.
SDCs the answer?
For too long, the US has pressed the dollar as a geostrategic tool during geopolitical conflicts in recent years. The freezing of dollar accounts during the Ukraine-Russia conflict is a case in point.
A Reserve Bank of India (RBI)-appointed committee on internationalization has suggested various measures, like allowing Indian banks to offer services in rupee overseas, permitting non-residents to open INR accounts, and withdrawing withholding tax on masala bonds, to accelerate the pace of internationalization of the domestic currency.
It may also be time to look at alternatives including sovereign digital currencies (SDCs), which can potentially lower dollar dependency in several ways.
For instance, countries can hold SDCs as reserves instead of USD, reducing dependence on the US dollar. SDCs can, at least in theory, facilitate international transactions and direct currency exchange, bypassing the need for USD as an intermediary. Besides, SDCs can provide an alternative to USD-dominated payment systems like SWIFT, and also give central banks greater control over monetary policy, reducing the impact of US dollar fluctuations.
There are, of course, multiple challenges including inter-operable infrastructure for SDCs to take on the might of the dollar. That said, any attempts at de-dollarisation should be approached as a process, and not an event.
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