De-dollarisation has been in the news for many years, but it has received disproportionate attention in the recent global economic crisis, which is understandable. The explanation is that the dollar has become weaponized as a result of the US government's decision to freeze Russia's dollar assets due to the conflict in Ukraine.
The United States never used its position of strength as the dominant global reserve currency responsible for further global economic transactions, nor did it manage its economy effectively as there were bouts of inflationary and recessionary periods that resulted in negative spillovers to global economies as a result of globalization. Second, global monetary policy is inextricably linked to the US dollar. According to the IMF, the dollar's share of official foreign exchange reserves decreased drastically from 84.85% in 1970 (a year before the greenback was totally established as the global reserve currency) to 58.36 percent in 2022, which is severely disproportionate to its share of global GDP.
According to the National Bureau of Economic Research, the euro has been unable to displace the dollar or emerge as a viable alternative due to a lack of high-quality euro-denominated assets that foreign investors and central banks may utilize as a store of value. The euro's share of foreign exchange reserves climbed by slightly more than 2% from 2000 and 2022.
Although the Chinese yuan is increasing its proportion of foreign exchange reserves, it is a regulated currency that is only permitted to float within a fixed bandwidth, and so its value has not been discovered by market forces. Furthermore, the economy's transparency remains a million-dollar concern. The Japanese yen, British pound, and Australian or Canadian dollars have limited scope since their respective countries' GDP growth or export potential is constrained. Globally, there is a perceived need for an additional reserve currency in the current multi-currency basket.
When judged against the performance and potential of the economy, exports, exchange rate, and price stability, the Indian rupee is positioned to be the one. The Indian economy has undergone significant change in the recent nine years. Its ranking among global economies has risen from 10 to 5, compared to the vulnerable five in 2013. It has been the fastest expanding among large economies for the previous two fiscal years in a row and is on track for a third. In addition, India is on track to become the world's third largest economy, with a GDP of $5 trillion.
The advantages do not stop there. Between 2013 and 2022, India had the greatest FDI influx as a proportion of GDP, followed by the United States, China, Japan, and Germany. According to Ernst & Young, India's GDP is expected to reach $26 trillion by 2047. According to Goldman Sachs, India will be the world's second largest economy by 2075.
Several times, India has defined its position on currency rate management: it intervenes in the FX market to reduce excess volatility, not to target any precise price level. While navigating the Covid-19, commodity, and currency crises, the rupee has demonstrated durability and strength, performing on pace with other global reserve currencies such as the euro, pound, and yen. Between the start of FY21 and the Ukraine war, the rupee, pound, and euro all rose. Since the outbreak, the yen has fallen by 23%, while the rupee and pound have fallen by 9.5%. The euro also fell by 5.5%.
The less-publicized but enormously successful component of India is its flexible inflation targeting system, which exploits price stability. India has managed inflation considerably better than Western countries over the recent three black swan occurrences, which had multidecadal high inflation levels. The RBI Governor's recent Governor of the Year award demonstrates India's success in managing inflation.
Apart from instilling trust in the rupee through the success and potential of its economy, as well as price stability, India has taken initiatives to increase the rupee's visibility abroad. Following the RBI's decision to allow foreign trade to be settled in rupees, India has launched a local currency settlement mechanism with Malaysia and the UAE to settle trade in their respective local currencies, eliminating the need for a third currency. Currently, 22 nations are discussing the potential of bilateral commerce in rupees with India.
In addition, India's UPI is linked to multiple countries' quick payment systems, allowing for cross-border remittances. Recently, India's standing on the global economic map was elevated with the inclusion of its government bonds in JP Morgan's Global Bond Index, and other agencies are expected to follow suit soon. Inclusion in a global bond index would put pressure on the government to maintain budgetary discipline and ensure that its bonds remain investment grade status, tying foreign investors to the country.
India is aware of partial capital account convertibility, but the trip to complete convertibility will be a process, not an event. India, led by Prime Minister Narendra Modi, has taken the required moves at the appropriate time and will take more in the near future. It may take some time for the rupee to be recognised as a currency in the global multiple reserve currency basket.