Homefinance News

View | Not just China plus one, the world needs a dollar plus two, if not three, strategy

View | Not just China plus one, the world needs a dollar plus two, if not three, strategy

View | Not just China plus one, the world needs a dollar plus two, if not three, strategy
Read Time
7 Min(s) Read
Profile image

By Sriram Iyer  Sept 28, 2022 10:46:36 AM IST (Updated)

It may be worthwhile for the world to increase the pace of de-dollarisation and arrive at a consensus on which currencies can make the cut as an alternative to the dollar. The peak of a crisis is often a good time for disruptive changes. 

The dollar index, the value of the American currency compared to a basket of other international currencies like the euro, pound sterling, the Japanese yen and others, is at its highest in nearly 20 years. A hundred British pounds, or Indian rupees, can buy fewer US dollars than ever before in history. 

Recommended Articles

View All

The American currency has been the king of the financial world since the end of World War II. It might (read value) increase even more when the world enters a crisis from time to time. Today, in an era of catastrophes – from a full-blown war to crippling shortages to escalating social strife and back-breaking inflation across the world – the dollar’s dominance is creating more problems for people worldwide instead of solving any. 
Part of the reason is that in many countries, particularly in Europe and Asia, central banks have been slow in raising interest rates, which would have brought inflation down and stopped the currency rout. The world’s over-reliance on the dollar is still the bigger chunk of the problem. 
Aside from Russian President Vladimir Putin and his counterpart in China, Xi Jinping, there are many influential voices around the world, across the political spectrum, calling for an alternative to the US dollar to be used more widely in international trade and investments.
When an authoritarian China seemed to get richer and more powerful, pretty much everyone in the democratic world easily agreed on the need to diversify their business in a way that they don’t invest (or rely) too much on China. It’s called China plus one strategy.
There is a similar need for the world to acknowledge the problems created by the US dollar being the only currency that is perceived to be safe when the world is in turmoil. When the money runs for cover, it should have a dollar plus one (if not more) strategy, too. 
The dollar’s unbridled rise makes the problem of inflation worse in less developed countries like India. It has increased the cost of borrowing and interest payments for European economies with high debt ala Greece, Ireland and Portugal. If the money that is owed is in dollars, the amount of local currency needed to repay the debt goes up when the dollar strengthens.
Americans import more than a trillion dollars worth of goods and services than what they export to the rest of the world. So, even for the US itself, the import bills will rise far more than it already is. 
The more the dollar rises in value, the cheaper it becomes for US companies to shift jobs to other countries. Fewer dollars can buy more stuff in currencies that are valued less.  
What can be a good alternative to the US dollar?
It will be another currency that is backed by a democratic government with stable and transparent economic policies, one that is open to international trade and investments, rated high on governance standards, and there is depth in the country’s economy and the financial markets. The country’s military might and technological advances have always been a factor in how attractive its currency is to the rest of the world.
It would help to have more than one currency take the dollar's place. So, if the value of any one currency sinks – due to variation in any of the factors mentioned above – the damage to international investments is limited. Many countries are already reducing the amount of reserves held in US dollars and increasing their holdings of other currencies. 
Countries wouldn’t want to be shut out of international financial markets because they angered America, as Putin learnt after his invasion of Ukraine. Much of the world woke up to the possibility of such risks, and many countries decided to have a plan B. 
The share of the US dollar in the forex reserves of all countries put together went down from over 70 percent in 1999 to 59 percent in 2021. For instance, Israel decided earlier in April 2002 that it would reduce the amount of the American greenback it holds and buy more of the currencies from Canada and Australia. The government in Tel Aviv decided to cut its holdings of euros by more than a third. 
China and Saudi Arabia are reportedly considering an agreement to settle payments in yuan. The Reserve Bank of India has allowed trade with other countries to be settled in rupees
Yet, it is still early days for de-dollarisation, the fancy term for the process of reducing the importance of the US currency in the world of finance. While the share of the US currency is declining, it is still the biggest medium of exchange in international trade, more than all other currencies combined, according to the International Monetary Fund (IMF). 
Just like an individual’s investments should be diversified to reduce the risk, countries are looking to not have all their eggs in one basket. 
Can the rupee become an international reserve currency?
This issue has been discussed for over a decade now. A 2010 study by the RBI called the rupee, along with the Chinese renminbi, “natural contenders” for the international reserve currency status. 
But, aside from the prestige and good business, the tag will also bring in a lot of volatility for an emerging market currency like the rupee. It can be particularly challenging for a country like India, which runs a large current account deficit. A current account deficit effectively means that India sends more foreign exchange out of the country than what comes in. 
So, the rise and fall in the rupee will be a lot sharper and more unpredictable if it becomes a freely traded currency in the global markets like the dollar is. The volatility will be a lot worse than what it is right now. 
Between 2010 and now, a lot has changed. The Indian economy is a lot bigger, its financial markets are a lot deeper, and there is still a long way to go before the rupee becomes a significant part of the international invoices.
India is taking steady steps toward making its currency more popular in the international markets by easing the restrictions. For example, in August 2022, the RBI allowed any Indian entity (which is not financial services) – and has a three-year profit track record – to invest anywhere in the world for financial entities without any permission from the central banker.  
As an economy, India has emerged as a safer destination for capital. Its potential as a market has always been beyond doubt. Expectations are rife that Indian bonds may get included in JP Morgan Global Bond Index. The economy’s stature and influence in the global arena are growing. 
However, there is still time to build its economic muscle to take on the battles that the internationalisation of the rupee may bring along with it. RBI has spent nearly $100 billion in trying to save the rupee from falling further in recent months. Still, the currency has hit a fresh record low multiple times.
Meanwhile, it may be worthwhile for the world to increase the pace of de-dollarisation and arrive at a consensus on which currencies can make the cut as an alternative to the dollar. The peak of a crisis is often a good time for disruptive changes. 
Check out our in-depth Market Coverage, Business News & get real-time Stock Market Updates on CNBC-TV18. Also, Watch our channels CNBC-TV18, CNBC Awaaz and CNBC Bajar Live on-the-go!