Who can dethrone the US dollar?

Source: The post is based on the article “Who can dethrone the US dollar?” published in Business Standard on 10^th July 2023.

Syllabus: GS 3 – Indian Economy – Growth & Development

Relevance: concerns associated with adopting alternatives payments system against dollars.

News: Countries around the world are taking measures for dedollarization and coming up with alternative transaction mechanisms. However, the factors that make the dollar an international currency must be considered.

What are the factors that make dollars an international currency?

Read – De-dollarisation of Trade

What have been the previous attempts to dethrone the dollar?

Japan: During the 1990s, Japan was the second-largest economy in the world, had good institutions, and it commanded confidence from the world on inflation, taxation, and capital controls.

It tried a big “industrial policy” push to establish the Japanese yen as a major international currency. However, the attempt failed.

Euro: After the failure of Japan, the euro emerged as a significant currency and the European Union (EU) began to rival the US as an economic powerhouse.

This gave the euro recognition as an international currency. However, the euro remains a minor player compared to the dominant position of the US dollar.

What measures are being taken by China?

The Chinese government is making efforts to promote the renminbi as a global currency. However, China faces more challenges compared to Japan.

China has strict capital controls, similar to India, which restrict the flow of money in and out of the country. The Chinese central bank primarily pegs the renminbi to the US dollar, which means it is not truly an independent exchange rate.

Further, China lacks confidence in managing inflation and taxation and it also does not have an appealing financial system that attracts non-resident investors or fundraisers Hence, this ambition of the Chinese state is likely to go unfulfilled.

What can be the way ahead for India?

First, India has the potential to become a major producer of internationalized financial services.

This can be achieved by implementing the recommendations of the Percy Mistry report on making Mumbai an international financial center and the Financial Sector Legislative Reforms Commission report by Justice Srikrishna.

Second, policymakers should aim to restore the pre-independence era where the rupee was widely trusted and used across South Asia, Southeast Asia, West Asia, and East Africa.

This requires maintaining good institutions over a period of 50 years, particularly regarding inflation, taxation, capital controls, and demonetization. In terms of inflation, the goal should be to sustain the 4 percent inflation target consistently over a 50-year period.