Introduction: What is dollarization?
Before we go into the growing concept of de-dollarization, it is necessary to understand the concept of dollarization. In simple terms, dollarization means the widespread use of the U.S. currency (dollar) as a medium of exchange, store of value, or unit of account in and during international transactions. Economist Steve H. Hanke popularized this term when he used this term “dollarization” to describe the phenomenon of countries adopting the U.S. dollar as their official currency or using it alongside or instead of their local currency in everyday transactions.
Dollarization occurs at two different levels: Official dollarization and Unofficial dollarization. Official dollarization refers to the state where a country adopts the U.S. dollar as its sole legal tender, relinquishing control over its own monetary policy and using the U.S. dollar for all domestic and international transactions. Ecuador and El Salvador have adopted the U.S. dollar officially.
In unofficial dollarization or partial dollarization, U.S. dollars are used partially either alongside or instead of the local currency in everyday transactions but the local currency has the legal tender. Zimbabwe, Cambodia, Panama, and East Timor have partial dollarization.
De-dollarization involves reducing the role of the U.S. dollar in international trade and financial transactions. In these countries, international associations and societies reduce the reliance on the U.S. dollar in this domestic or regional economy. De-dollarization has a significant impact at the global level impacting the global financial system. Reducing the dependence on the U.S. dollar impacts the exchange rate, interest rates, and international trade patterns.
Different efforts to de-dollarization
Different countries have made several efforts towards de-dollarization either to reduce the dependence on the dominant U.S. dollar or due to various geo-political and financial reasons. Some of such efforts made are:
Russia has been actively involved in reducing its dependence on the US dollar. The government and the central authorities are actively diversifying its foreign currency reserve and have made different agreements with several countries on currency swap to facilitate trade and investment in local currencies. Russia has been actively promoting the use of currencies like Russian ruble (RUB), Chinese Yuan (CNY), and the Euro (EUR). Similarly Russia has been promoting its trade relationship with countries who are not heavily reliant on the US dollar for international trade such as China, India and Iran.
In 2020, the share of the US dollar in Russia’s trade turnover decreased to around 50%, while
The U.S. imposed sanctions on Iran. As a response, Iran has been focusing on de-dollarization to reduce its vulnerability of dollar dominance. Iran has started accepting other currencies like yuan, euro and local currencies for international transactions. Similarly, Iran has entered into different bilateral payment agreements with various countries to reduce the U.S. dollar-dominated financial system.
China is one of the largest economies and a major trader. The geo-political differences with the U.S. and U.S, time and often sanctions on Chinese products have forced China to actively discourage dollar consumption and encourage use of yuan for international trade. The Bank for International Settlement has published data which suggests that the share of yuan in global trade finance has increased from 2.8% in 2012 to 15.9% in 2019.
India has also been into the march to promote Indian Rupees across the globe. The expansion of Indian currency as a mode of international payment and trade settlement, has encouraged the de-dollarization. India has entered into currency swap agreements with various countries including Japan, UAE, Bhutan, and Sri Lanka. Now, There are 18 countries which can transact in Indian Rupee.
Together with these countries and their strategies, there are many more countries who are encouraging the use of local currencies and promoting their currencies for international trade and transactions.
Reasons for De-dollarization
There are multiple reasons why countries and unions across the world want to minimize the reliance on the US dollar for and in international trade. Some of the basic and prominent reasons are:
Diversification of Currency Reserve
Every country has a significant hold of foreign currency reserves. In this foreign currency reserve, the U.S. dollar is dominant. However, relying heavily on the U.S. dollar and holding the reserve could lead to risks related to currency fluctuations. In this scenario of holding only a single currency, fluctuation in the currency could impact international transactions and trade. In case of depreciation of the U.S. dollar, the country could face a downfall.
To avoid this and to allow financial stability, countries are diversifying the currency reserve and are holding different currencies based on their international trade and transaction. Diversification always avoids the risk.
Avoiding U.S. Sanctions
The United States is the largest economy in the world. It directly or indirectly impacts the global economy. The U.S. sanction is one of the foreign policy tools to achieve its political, economic, and national security objectives. The recent sanctions of the United States on China, Russia, Pakistan, Iran etc. impact the economy of the sanctioned countries. In such a dominant and volatile trade and political relationship with the United States, considering the U.S. dollar as instruments for international trade is vulnerable.
De-dollarization can be seen as a way to reduce its dependency on the U.S. dollar and to reduce the impact of U.S. sanctions. It is very much evident that U.S. sanctions are geo-political and economical and generally have a negative impact on the economy of the sanctioned country.
Protecting National Sovereignty
The dependency on a single currency i.e. the U.S. dollar could make the country vulnerable. There are many countries with the U.S. dollar as a legal tender. Such adaptation affects national sovereignty. Also, depending on a single currency exerts an additional economic pressure. Such dominance of a single currency disturbs economic independence and national sovereignty. Such dependence also makes the economy very volatile and vulnerable.
In 2000, Ecuador adopted the US dollar as its legal tender to fight the hyperinflation and severe economic crisis. After this, Ecuador has become dependent on the U.S. for its economic and monetary policy and other economic decisions.
Promoting Regional Integration
De-dollarization is also a strategy to promote bilateral relations and other regional integration. Currency swaps between two countries encourage economic activities among the countries and establish trade and economic cooperation.
De-dollarization also helps countries to bypass the U.S. dominance. In 2010. Brazil and Argentina agreed to use their own currency in bilateral trade. Similarly, In 2019 Russia and China agreed to use their own national currencies in bilateral trade.
Similarly, in 2014 BRICS nations New Development Bank (NDB) as an effort to promote regional financial cooperation and reduce the dependence on the U.S. dollar.
Sometimes de-dollarization is adopted as a strategy for geopolitical consideration. There are many countries that restrain their relationship with the United States due to geopolitical reasons. Also, there are many countries that consider the U.S. dollar and exchange reserve as a tool of U.S. dominance. Such countries adapt to de-dollarization as a strategic tool to reduce the reliance on the U.S. dollar and to establish a fair share in the global exchange and transaction market
For instance, China is one of the largest exporters in the world. The social, political and social culture of China differs from that of the United States. Due to the differences between the countries and to strengthen the position in the global trade market, China often enters bilateral agreements with its importing countries. Meanwhile,
Exploring Alternative Payment Mechanism
De-dollarization is also the need of time. With a growing economy, changing environment and development in technology, dominance of the dollar exerts additional economic pressure. De-dollarization allows countries to explore new alternative payment mechanisms, digital currencies or blockchain-based solutions.
Unlike dollarization, digital currencies and other alternative payment mechanisms can provide decentralized and independent channels for conducting transactions within a region or among countries. This also helps countries hedge against geopolitical risks associated with potential disruptions or sanctions on U.S. dollar transactions.