Internationalization of the domestic currency 

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Its advantages and associated risks

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It is a process that involves increased use of domestic currency in cross-border transactions. Excessive dependence on dollars combined with global inflation and economic crises has led to the depreciation of the domestic currency. If the currency were internationalized, a country would not have to depend on US dollars for its trade.

It involves promoting the local currency for import and export trade and other current account transactions, followed by its use in capital account transactions. Current and capital accounts are the two components of the balance of payments. The current account is concerned with the import and export of goods and services, whereas the capital account is concerned with the cross-border movement of capital through investments and loans.

The dollar accounts for 88.3% of global foreign exchange market turnover, followed by the euro, Japanese yen, and pound sterling.

The Benefits of Internationalisation:

  • Appreciate currency value: It will improve the demand for domestic currency in international trade.
  • Payments in local currency can help to reduce the price volatility associated with dollars.
  • Reduced Foreign Exchange Reserves requirement due to reduced dependence on Foreign Currency for Trade.
  • Improving acceptance and trade can help diversify the trade basket by circumventing restrictions and sanctions imposed by the west.
  • Improve the currency’s standing as a global economic power
  • The use of local currency in cross-border transactions mitigates currency risk for Indian businesses. Protection from currency volatility not only reduces the cost of doing business; it also enables better growth of the business, improving the chances for businesses to grow globally.
  • Reducing dependence on foreign currency makes countries less vulnerable to external shocks.
  • Lower transaction costs of cross-border trade and investment.

Challenges and Risks in Internationalisation 

  • make domestic monetary policy more challenging.
  • It involves non-residents holding local currency, which would be used to acquire local assets. Such assets could heighten vulnerability to external shocks.

The Egyptian central bank announces a plan to move its currency away from the US dollar. They announced that they are looking to develop a new currency indicator in order to “change the culture that we are linked to the US Dollar”. Egypt is now the latest nation to start moving away from the US Dollar in the aftermath of the Russia-Ukraine war.

Earlier this year, both Iran and India dumped the dollar in their bilateral trade with Russia, while Saudi Arabia has proposed switching from the US currency to the Chinese Yuan in all future oil supplies to China. Last month, reports claimed that Egypt has been preparing to adopt Russia’s Mir payment system and include the Russian ruble in the list of currencies used by Egyptian banks and tourism companies. In June, Iran proposed a new currency for trade with China, Russia, India, Pakistan, and other members of the Shanghai Cooperation Organisation (SCO).

Given the US dollar’s dominance in international trade for the last 70 years, these de-dollarization efforts around the world are noteworthy. The shift from a dollar-centric to a more fragmented geoeconomic system appears to be intensifying, and the immediate economic, geopolitical, social, and financial ramifications will be worth monitoring over the next five years.

Source: IE