Context:
Argentina, plagued by severe inflation and widespread poverty, faces a pivotal moment. Dollarisation is seen as a potential remedy for the country’s economic challenges.
Relevance:
GS III: Indian Economy
Dimensions of the Article:
- Dollarization’s Economic Impact: Strategies and Benefits
- Major Challenges Associated with Dollarisation
- De-dollarisation: Reducing Reliance on the US Dollar
Dollarization’s Economic Impact: Strategies and Benefits
Curbing Hyperinflation:
- Dollarization introduces the stable United States Dollar, breaking the cycle of hyperinflation driven by uncontrolled money supply.
- Stabilization fosters economic confidence, encouraging investment and consumer spending.
Export-Oriented Strategies:
- Dollarization incentivizes a shift toward export-oriented strategies, promoting economic growth.
Foreign Investor Attraction:
- A stable currency attracts foreign investors, fostering foreign trade and enhancing economic stability.
- Predictable dollar value allows for more accurate long-term economic planning by businesses.
Mitigating Speculative Risks:
- Dollarization mitigates risks associated with fluctuating exchange rates, making the economy more attractive to foreign investors.
Fiscal Policy Emphasis:
- Dollarization shifts control away from monetary policy, prompting reliance on fiscal policies for economic stability.
- This shift encourages prudent fiscal management, potentially curbing government overspending.
Ecuador’s Dollarization Experience: Lessons Learned
Initial Challenges:
- Ecuador faced political upheaval following dollarization in 2000.
Economic Progress:
- Despite challenges, Ecuador experienced reduced inflation rates, lowered debt ratios, and improved social welfare.
Contributing Factors:
- Economic progress in Ecuador was not solely attributed to dollarization.
- Booming oil and gas reserves and expanded government intervention played significant roles in sustaining prosperity.
Major Challenges Associated with Dollarisation
Limited Monetary Policy Independence:
- Dollarisation significantly constrains a country’s ability to independently manage monetary policy.
Loss of Control Over Money Supply and Interest Rates:
- The loss of control over money supply and interest rates can impede the government’s responsiveness to economic downturns.
Vulnerability to External Economic Shocks:
- Fixed currencies in dollarized economies may heighten vulnerability to external economic shocks.
Lack of Exchange Rate Flexibility:
- The absence of flexibility in adjusting exchange rates leaves dollarized economies unable to counterbalance sudden changes in the global economic environment.
Greece’s Warning Example:
- The situation in Greece serves as a cautionary example of challenges associated with adopting a foreign currency.
- Despite some growth, the Eurozone crisis highlighted the difficulties of using a currency without control over its policies.
Budgetary Constraints and Financial Assistance:
- Greece, after adopting the euro, faced the necessity of accepting strict budget cuts and financial assistance, revealing the limitations of using a foreign currency.
Restriction on Currency Devaluation:
- Loss of control over the exchange rate limits a country’s ability to use currency devaluation as a tool to enhance export competitiveness.
Inadequate Addressing of Internal Structural Issues:
- Dollarisation may not effectively address internal structural issues within an economy.
Dependency Overshadowing Reforms:
- Relying on a foreign currency might overshadow the need for internal reforms, such as productivity improvements or addressing income inequality, essential for sustained economic development.
De-dollarisation: Reducing Reliance on the US Dollar
- De-dollarisation is a deliberate or unintentional process undertaken by a country or region to diminish dependence on the US dollar within its financial system or economy.
Measures Involved:
- Involves various measures aimed at decreasing the use of the dollar in transactions, reserves, trade, or as a standard for pricing goods and services.
Reasons for Pursuit:
- Governments may pursue de-dollarisation to reduce exposure to the impact of US monetary policy.
- Asserting economic sovereignty, mitigating the effects of dollar fluctuations, or seeking greater independence in global finance are additional reasons.
Strategies for De-dollarisation:
- Strategies include diversifying currency reserves, promoting alternative currencies in trade agreements, establishing currency swap agreements, or encouraging the use of regional currencies in financial transactions.
Example: RBI’s March 2023 Initiative:
- In March 2023, the Reserve Bank of India (RBI) implemented a mechanism for rupee trade settlement with 18 countries.
- Banks from these countries were permitted to open Special Vostro Rupee Accounts (SVRAs) for settling payments in Indian Rupees.
-Source: The Hindu
