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Can Dollarisation save an Economy

By Amigos IAS

Why is it in the news?

  • Argentina, grappling with severe inflation and widespread poverty, contemplates a crucial economic shift.
  • The newly elected President vows to replace the Argentine Peso with the U.S. Dollar, viewing dollarisation as a potential remedy. However, immediate implementation faces hurdles due to the scarcity of dollar reserves in Argentina.

 

Benefits of Dollarisation

 

Stabilizing Inflation: Introduces a stable currency to curb hyperinflation; Breaks the cycle of rising prices linked to uncontrolled money supply.

 

Enhanced Trade Opportunities: Incentivizes export-focused strategies in a dollarized economy; Stable currency attracts foreign investors, fostering foreign trade.

 

Long-Term Planning: Stable dollar value facilitates accurate long-term economic planning; Businesses can make more accurate forecasts without the volatility of a depreciating domestic currency.

 

Reduced Speculative Risks: Mitigates risks associated with fluctuating exchange rates; Stability attracts foreign investors, promoting capital inflow and economic growth.

 

Financial Discipline: Forces governments to rely on fiscal policies for economic stability; Encourages more prudent fiscal management, curbing government overspending.

 

Ecuador’s Experience

·       Despite initial upheaval post-dollarisation in 2000, Ecuador experienced significant economic progress.

·       Reduced inflation rates, lowered debt ratios, and improved social welfare.

·       Success attributed not solely to dollarisation as booming oil and gas reserves during the 2000s and expanded government intervention played crucial roles.

 

 

Challenges of Dollarisation

 

Policy Constraints: Limits a country’s ability to manage monetary policy independently; Loss of control over money supply and interest rates hampers response to economic downturns.

 

Economic Shock Vulnerability: Fixed currency makes economies vulnerable to external shocks; Lack of flexibility to adjust exchange rates in response to global economic changes.

 

Limited Export Competitiveness: Loss of control over the exchange rate restricts currency devaluation for export competitiveness.

 

Inability to Address Internal Imbalances: Dollarisation may not address internal structural issues;     Dependency on a foreign currency might overshadow the need for internal reforms crucial for sustained development.

 

·       In 2022, the IMF observed that central banks around the globe were not maintaining the same levels of reserves in the US dollar, as they had done in the past.

 

De-dollarisation

 

Deliberate or unintentional process to reduce reliance on the US dollar.

 

Reasons:

·       Reducing exposure to US monetary policy.

·       Asserting economic sovereignty.

·       Mitigating effects of dollar fluctuations.

·       Seeking greater independence in global finance.

 

Strategies:

·       Diversifying currency reserves.

·       Promoting alternative currencies in trade agreements.

·       Establishing currency swap agreements.

·       Encouraging the use of regional currencies in financial transactions.

 

RBI’s Efforts:

·       In March 2023, RBI mechanism for rupee trade settlement with 18 countries.

·       Banks allowed to open Special Vostro Rupee Accounts (SVRAs) for settling payments in Indian Rupees.

 

 

Conclusion

  • Dollarisation, with effective domestic policies, paves the way for economic success.
  • Efficacy hinges on nuanced policy execution, balancing stability with the need for independent economic strategies.

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