Dollarisation - why is it worrying the Indian central bank and how cryptos can trigger it

• Cryptocurrencies can cause ‘dollarisation of the Indian economy,’ RBI officials are known to have told a parliamentary panel.
• As per the argument presented by RBI officials, cryptocurrencies are dollar-denominated and also issued by foreign private entities.
• Countries which have been victims of hyperinflation like Bolivia have become dollarised, with over 80% of the currency in use being dollars.
• As much as 86% of both Indian imports and exports are invoiced in dollars while only 5% of its imports and 15% of its exports are from the US.

There are many arguments that the Indian central bank has come up against cryptocurrencies. The latest, according to a media report on a parliamentary panel discussion, seems to be the ‘dollarisation of the Indian economy’ by cryptocurrencies.

Ideally, the extensive use of cryptos should cause ‘cryptorisation’ but why would it make dollars more prevalent in India? After all, cryptocurrencies were created by people disillusioned with all fiat currencies and even dollar issuers are not too keen on them.

As per RBI officials, cryptocurrencies are dollar-denominated and also issued by foreign private entities which could lead to dollarisation. They are also known to have said that cryptocurrencies have the potential to become a medium of exchange and replace the rupee in financial transactions both domestic and cross-border — thereby replacing a part of the Indin monetary system.

Apart from being used as payment for goods and services, cryptos can also be exchanged for fiat currencies and the US Dollar is the most preferred for this exchange. Most Indians who buy cryptos, convert rupees to dollars, in order to buy them.

What is dollarisation and how does it affect an economy?

Dollarisation is a form of currency substitution, where dollars are used in addition to or instead of the local currency of a country. Though only tax havens like Liberia and Panama can be defined as ‘dollarized’ in a true sense, there are many economies dollarised to a large extent. In fact, two-thirds of dollars are held outside the United States which issues it. Countries which have been victims of hyperinflation like Bolivia have become dollarised too, with over 80% of the currency in use being dollars.

In spite of its current inflation troubles, India is far away from dollarisation to this extent. However, there are research papers that suggest that Indian EXIM transactions are dominated by dollars.

As per an article by Gita Gopinath who is now the deputy managing director of International Monetary Fund, 86% of both Indian imports and exports are invoiced in dollars. Only 5% of India’s imports and 15% of exports are from and to the US — showing that few countries use their own currencies for international transactions due to the popularity of the dollar abroad.

Central banks versus cryptos/dollars

Central banks of economies with high dollarisation, become bodies with no power. Their monetary policies which govern the local currency, will have no effect on an economy ruled by a foreign currency.

In fact, this is one of the reasons why the Reserve Bank of India has been opposing it and the Indian finance ministry too backed their fears by imposing a 30% crypto tax on it without officially ‘allowing’ it in India. This move aimed to stall Indian rupees going up into purchasing virtual assets which will then be owned by foreign entities - that cannot be tracked by tax authorities here. The tax does not apply to individuals who mine cryptos to earn them but only to those who spend Indian rupees to acquire or trade in it.

The central bank is always worried about the movement of the Indian rupee and now more than ever it is extra vigilant with high inflation, devaluation and of course fears of possible stagflation looming large.

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