Have you ever thought about why the dollar is the global currency? Is it because the US is the world’s biggest superpower and economy? Yes! This is the truth, but it is only half the story. During World War II, in 1944, the Bretton Woods System was created by world leaders with the aim of creating a stable post-war economic order.
The system established fixed exchange rates between national currencies and the US dollar, which was set at a fixed value to gold. Other countries started to peg their currencies to the US dollar, which in turn was backed by gold. This effectively made the US dollar the global reserve currency, as countries held large reserves of dollars as a means of facilitating international trade and investment.
The system worked efficiently for a few decades. But it was ultimately abandoned in 1971, when the US government ended the convertibility of the dollar to gold due to growing trade imbalances and inflation. Hence, the floating exchange rate became prominent.
But the dollar sustained its status as a global currency. After almost 50 years, things have changed across the world. There are countries like China and India, among others, that are discussing de-dollarizing trade in local currency.
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India-Bangladesh: Start of a new chapter
According to reports , India and Bangladesh agreed to trade in their local currencies. This development was discussed alongside the G20 Finance Chiefs meeting on February 24–25. The development is expected to reduce the cost of trade as well as losses due to rupee and yen differences. It is estimated that Bangladeshi citizens spend almost $2 billion per year in treatment, tourism, and education in India.
It is interesting to know that India is among the top 3 import destinations for Bangladesh. Both governments are desperate to increase trade and cooperation for mutual benefit. To make trade flow swifter and to ease the procedures for transactions across the two countries, the leadership is planning to introduce ‘Dual Currency Cards’.
The cards could be used in either country to get the subsequent currency disbursed. The exchange rate would be derived from the two currencies and not be worked backwards from the exchange rate of the dollar. At first, the idea of Taka-Rupee trade was brought up at a meeting of Bangladesh’s National Economic Council, chaired by Prime Minister Sheikh Hasina.
According to Bangladesh Bank Governor Abdur Rauf Talukder, the trade in taka will ease the pressure of foreign currency because a large portion of Bangladeshi trade that takes place with India will not require the foreign currency.
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Second country in the region
After both official announcements, Bangladesh will become the second country on the subcontinent to trade in rupees. It must be noted here that, last year, Sri Lanka became the first country on the subcontinent to initiate the procedure. With respect to its decision to accept the INR as a foreign currency, the Bank of Ceylon opened its first INR account with its Chennai Branch in December.
As of now, the country is trading in Indian rupees, due to which it is facing fewer problems keeping the forex intact in the current economic breakdown. Apart from that, Russia is also making trade settlements with India in INR. Recently, the Russian Ambassador, Denis Alipov, confirmed that the mechanism for rupee-rouble trade is established. It is noteworthy that Russia has given up the dollar and euro altogether.
On the other hand, the UAE is also in talks to initiate rupee-dirham trade. But it is not only India that is aspiring to make its currency global. China is too in the pursuit. In fact, it has worked for a long time. In 2009, China attempted to develop a reserve currency.
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China bids for yuan
On Dec. 1, 2015, the International Monetary Fund (IMF) announced that it had awarded the yuan status as a reserve currency. The IMF added the yuan to its Special Drawing Rights basket on October 1, 2016. Before becoming a global currency, it must first become a reserve currency. The reserve currency is one that is held by central banks and institutions across the world for trade.
The Chinese managed pegged the yuan to the dollar. Fortunately, since 2015, the floating peg has shown a downward trend. This simply means that the yuan is devalued against the dollar. The export for each dollar increased in volume, making the export competitive.
Let me put it in a simple way: Assume that China exports 3 units of a product to the US for $3. That means China gets $1 for each product it exports. As per the conversion rate, 6.91 Chinese Yuan equates to $1. Now, if the Yuan devalues to 10.365 per USD, 3 such products would be delivered to the US for just $2. This simply means that for the US, Chinese imports will become cheaper, and hence low-cost exports will increase competitiveness.
This was the policy of China that made it the most relevant economic force in the world. Eventually, the increased exports led to economic growth and increased international trade for China. As of now, more than 100 countries use the Chinese yuan as a trading currency. But when, the question of it becoming the global currency is raised, It looks more farfetched simply because of many reasons.
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14 years and still a failure, why?
For the yuan to become a global currency, it needs central banks around the world to keep $700 billion worth of yuan as foreign exchange reserves. If somehow the Yuan manages to do so, there are still other reasons why it may fail to become a global currency. First among them is the lack of transparency in the financial markets.
Along with that, unlike the US, the monetary policies of China are financially unstable. In terms of currency stability, the Yuan lags far behind the US Dollar and is likely to remain so in the future. So ultimately, it is the trust factor that is limiting the Yuan’s global aspiration.
Since China lacks democracy and has a strong centralised single-party system, the media and other institutions have been reduced to being merely the mouthpiece of the Chinese leadership. As a result, each economic claim and figure by the Chinese government comes under suspicion.
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India has an edge
So where is India in all this? Let us aggregate to understand. To become a global currency, the rupee must first become a reserve currency And for that purpose, the central banks across the world will have to have INR as foreign exchange reserves.
This can only become possible through a bilateral push with different countries. The biggest edge that India has over China is trust. The transparency, stability, and reliability of the democratic institutions… will drive other countries to use the INR without any hesitation. So, after almost 14 years of what China has not conceived, India will attain it easily.
Once the bilateral trade with the maximum number of countries starts in rupees, the extra-India, inter-country trade will need to be emphasised. After that, the INR would become the global currency. So what is happening with Bangladesh and what has happened with Sri Lanka and Russia is nothing more than a kick start to make the rupee a reserve currency and a regional currency first. India is slow and steady but seems to be crossing the early-starting China and hence will surely win the race.
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