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.