Towards A Fairer World Order

The ability of the United States to wield the dollar as a tool for imposing sanctions underscores the need for a re-evaluation of the international economic structure. India is taking the lead in encouraging the use of the rupee in world trade and finance, while contributing to the broader worldwide movement to diversify currencies to promote a more equitable and resilient global financial system

The enduring hegemony of the United States dollar in international trade has far-reaching implications, causing ripple effects across the global economic landscape. It has cascading consequences in terms of fuelling inflation, driving up oil prices, and enforcing international sanctions. Recent global geopolitical developments, particularly the imposition of US sanctions against Russia and Iran, have reignited debates surrounding the US dollar’s unquestionable dominance as the world’s primary reserve currency. Furthermore, the ongoing depreciation of the Indian rupee, driven by the relentless ascent of the US dollar, raises pertinent questions regarding its effects on various economic sectors, especially in the context of India’s impressive economic growth.

Unveiling the Power of the US Dollar

The United States has, since the onset of the Russia-Ukraine conflict in 2022, implemented a series of sanctions against Russia. These sanctions included restrictions on dollar transactions with the Russian central bank, creating hurdles for Russia in accessing the US dollar. The consequences of these actions have reverberated not only through the Russian economy but also across nations engaged in trade with Russia, spotlighting the risks of heavy reliance on the dollar in international transactions. These unilateral measures taken by the USA and its allies have kindled concern and curiosity among nations worldwide.

Historical Context: The Gold Exchange Standard

Post-World War II, the United States established a gold exchange standard, enabling countries to exchange $35 for an ounce of gold, even though it lacked the reserves to fully back its currency. This audacious move bolstered the US dollar’s credibility. Countries, drawn by the interest earned on their dollar deposits, began accumulating dollars instead of gold, ultimately fostering its acceptance as a widely-used global currency for international trade.

Trajectory of Rupee-Dollar Exchange Rate

Over the past three years, a majority of the world’s largest economies, including the United Kingdom, Germany, and Italy, have grappled with economic distress primarily stemming from inflationary pressures. The US dollar reached its highest level since June 2002 on September 19, 2022, with substantial gains against various currencies. Notably, it surged by 22% against the yen, 13% against the Euro, and 6% against emerging market currencies like those of the UAE, Argentina, and Mexico within the same year.

Experts from the International Monetary Fund (IMF), Gita Gopinath and Pierre-Olivier Gourinchas, have highlighted the macroeconomic implications of this rapid dollar strengthening, underscoring the dollar’s significance in international trade and finance. India, despite facing similar challenges, has effectively managed its economy by raising its benchmark interest rate (repo) to curb inflationary pressures and simultaneously offering incentives for industrial production to boost real economic growth.

Over the past decade, the overreliance on the US dollar as the primary international medium of exchange has granted the US the power to unilaterally impose sanctions on countries such as Iran and Russia. These sanctions not only affect the target countries but also impact other nations, particularly emerging economies like India, UAE, Argentina, and Mexico

However, the continuous depreciation of the Indian rupee is a matter of concern, stemming not from domestic economic instability but rather from the persistent strengthening of the US dollar. Finance Minister Nirmala Sitharaman emphasised in her October 17, 2022 statement that the Indian rupee was not weakening but that it was the US dollar that had significantly strengthened. She also mentioned that the Reserve Bank of India (RBI) is actively working to manage the rupee’s volatility and that the currency would naturally find its appropriate level. The strategic utilisation of reserves by the RBI through timely open market operations, including selling US dollars in the market, serves as a safeguard against excessive depreciation of the Indian currency, albeit leading to a depletion of forex reserves.

Impact of Dollar-Linked Value on Domestic Currencies

The depreciation of many nations’ currencies relative to the US dollar has complicated inflation control efforts. It is estimated that a 10% increase in the value of the US dollar results in a 1% increase in inflation. This phenomenon is more pronounced in emerging markets, characterised by growing economies and often less stable currencies. These countries heavily rely on imports, and a substantial portion of their imports is priced in US dollars. A stronger US dollar means that it takes more of their local currency to purchase the same amount of imported goods, leading to higher prices for consumers and contributing to inflationary pressures.

In contrast, advanced economies, with more stable currencies and a higher proportion of domestically produced goods, experience a lesser inflationary impact from a strengthening US dollar.

Oil Price and Its Inflationary Impact

The soaring oil prices are a major contributor to the rising inflation in emerging economies in the Asia-Pacific and Africa regions. This increase can be attributed to both OPEC+ production cuts and the depreciation of the Indian rupee due to the appreciating US dollar. The result is elevated oil costs, even in the absence of changes in oil supply. This scenario underscores the negative impact of dollarisation on the economy.

The BRICS countries (Brazil, Russia, India, China, and South Africa) have been discussing the creation of a new currency to compete with the US dollar as the world’s reserve standard. This idea gained momentum due to the continued use of the US dollar as a tool in trade conflicts and sanctions

The Growing Dominance of the US through Dollar-Based International Trade

Over the past decade, the overreliance on the US dollar as the primary international medium of exchange has granted the US the power to unilaterally impose sanctions on countries such as Iran and Russia. These sanctions not only affect the target countries but also impact other nations, particularly emerging economies like India, UAE, Argentina, and Mexico. When the US re-imposed oil sanctions on Iran in 2018, India had to reduce its oil imports from Iran by 80%, shifting its oil sources to Iraq, Saudi Arabia, and the United Arab Emirates.

More recently, in May 2022, the US extended its sanctions to prohibit any country from purchasing rough diamonds from Russia. This move significantly impacted India’s diamond polishing industry. As the world’s largest diamond cutting and polishing centre, India faced a substantial setback as the US government froze fund transfers worth $26 million from multiple offshore firms associated with the Indian jewellery industry for alleged imports of rough diamonds from Russia.

Recent global geo-economic developments have once again underscored the concerns surrounding the overreliance on the US dollar. This reliance has granted the US significant influence over global trade and finance, enabling the enforcement of sanctions that have far-reaching impacts on various industries and countries. These events have brought the significance of de-dollarisation to the forefront of discussions among nations worldwide. India, in particular, has taken proactive steps to promote the use of its currency, the rupee, in international trade by allowing invoicing and payments in rupees for trade with 18 countries.

India’s De-Dollarisation Drive

An increasing number of countries, including Brazil and various Southeast Asian nations, are advocating for diversifying the currencies used in international trade, moving away from exclusive reliance on the US dollar. While the US dollar continues to maintain its dominant position in global foreign exchange reserves, its share in central banks’ reserves has decreased over the years, according to an IMF data.

In 2019, European countries and Iran signed an agreement called Instrument in Support of Trade Exchanges functions (INSTEX), functioning as a barter system operating outside the US-centric global financial system. INSTEX aims to facilitate trade in non-sanctionable necessities like agricultural, medicinal, and humanitarian products, offering a viable alternative to US dollar transactions.

In August 2023, the Indian Oil Corp made a payment to the Abu Dhabi National Oil Company (ADNOC) in Indian rupees for the purchase of a million barrels of oil. This development indicates the potential for more trade with Middle Eastern and BRICS partner countries to be conducted in Indian rupees

Geopolitical tensions and uncertainties have encouraged nations globally to seek alternatives to the dollar to reduce their vulnerability to US policy decisions and sanctions. The freezing of approximately $300 billion of Russia’s foreign exchange reserves by the US and its allies in March 2017 exemplifies the risks associated with overreliance on the US dollar. Changing economic dynamics, such as the rise of emerging markets and the internationalisation of their currencies, have provided more viable options for conducting trade in alternative currencies.

While the US dollar’s influence remains significant, the global trend toward diversification reflects a broader desire for increased stability and autonomy in international financial transactions.

India’s push to encourage rupee trade serves as a positive example for other nations seeking to reduce their reliance on the US dollar. The potential impact of initiatives like paying for Russian crude in rupees, with Russia’s cooperation due to geopolitical reasons, demonstrates the significance of these efforts. However, it also highlights the entrenched position of the US dollar in global finance.

The BRICS countries (Brazil, Russia, India, China, and South Africa) have been discussing the creation of a new currency to compete with the US dollar as the world’s reserve standard. This idea gained momentum due to the continued use of the US dollar as a tool in trade conflicts and sanctions. Many nations aspire to be more independent of the US financial system, seeking a more balanced international trade environment and greater autonomy from the US-centric financial system.

The BRICS organised a summit on de-dollarisation during August 22-24, 2023, with the participation of more than 40 heads of states. China and India attempted to stimulate trade with sanctioned Russia by using three local currencies: the Yuan, Rupee, and Rouble. This symbolic move aimed to reduce reliance on US dollars in international commerce, at least among their member countries. However, given the close economic ties of most BRICS countries with Western nations, fully abandoning the dollar in favour of the BRICS countries’ indigenous currencies poses significant challenges.

India should focus on opening new channels for settling payments in Indian rupees with its partner nation groups, such as ASEAN and the African Union. Initiating new payment settlement mechanisms, similar to INSTEX in Europe, can help facilitate trade in Indian rupees, particularly with multinational companies attracted by the production-linked incentive scheme (PLI).

A New Opportunity for India

In August 2023, the Indian Oil Corp made a payment to the Abu Dhabi National Oil Company (ADNOC) in Indian rupees for the purchase of a million barrels of oil. This development indicates the potential for more trade with Middle Eastern and BRICS partner countries to be conducted in Indian rupees. With the possibility of Saudi Arabia joining the BRICS network, India could have the opportunity to purchase oil in its local currency. Buying oil in US dollars depletes a country’s foreign exchange reserves and results in higher costs due to the depreciation of the local currency against the dollar. In the fiscal year ending March 2022, India’s oil import bill doubled to USD 119 billion, constituting 28% of the country’s total import bill.

The Way Ahead

India should focus on opening new channels for settling payments in Indian rupees with its partner nation groups, such as ASEAN and the African Union. Initiating new payment settlement mechanisms, similar to INSTEX in Europe, can help facilitate trade in Indian rupees, particularly with multinational companies attracted by the production-linked incentive scheme (PLI). These efforts can open up new avenues for de-dollarisation, offering greater economic autonomy for India and contributing to a more balanced international trade environment. India can continue to champion the de-dollarisation issue on the global stage in forums like the Non-Aligned Movement (NAM) summit, India-ASEAN summit, India-Central Asia Summit, and others, promoting a more diversified and resilient global financial system.

References

-The writers are student of Institute of Management, Nirma University, Ahmedabad, India. The views expressed are personal and do not necessarily reflect the views of Raksha Anirveda