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Cryptos can lead to dollarization of economy!

By- Aditi Maheshwari

Date:19-May-2022


Dollarization is a form of currency substitution where dollars dominate instead of the local currency of the country. Best examples are tax havens like Liberia and Panama, who can be classified as “dollarized”. Bolivia – victim of hyperinflation has become dollarized with over 80% of the currency in use being dollars. Well, truth is central banks of economies dominated by dollarization have lost control over their financial system. They are merely standing with no actual powers. Main concern is that major cryptocurrencies are dollar-denominated and issued by foreign private entities, eventually leading to the risk of dollarization of a part of our economy. 


What reinforces the fear of dollarization is the fact that many economies to a large extent have become dollarized and two-thirds of dollars are held outside the US which issues it.  The biggest trap that needs to be avoided at all cost is that, the local authorities have no control left whatsoever over the monetary/fiscal policies which govern the national currency. In fact, this is why RBI has been skeptical about cryptocurrencies and believe it to be against the sovereign interest of India.


Well, Feb.1, 2022; holds great significance with regard to cryptocurrency in Indian context. Reason being the government of India after contemplating a ban on cryptocurrency last year finally made it to the Union Budget earlier this year, where our finance minister Nirmala Sitharaman introduced a tax on trading in cryptocurrencies and related assets like non-fungible tokens (NFTs) at 30% and 1% of tax which will be deducted at source (TDS) when any such transaction takes place, without officially allowing it. 1% TDS is believed by many as a masterstroke helping the government in tracing every such transaction. The motive behind this move is to stall Indian Rupee going up in purchasing virtual assets which will be owned by foreign establishments – non-traceable by local tax authorities. Note here, that tax is not applied on individuals who mine cryptos to earn them but only on those who spend Indian Rupees to acquire or trade it. Most Indians who buy crypto, convert Rupee into dollars to purchase them. Though decentralization lays the power in the hands of individuals yet this move by government to regulate it is greatly needed and appreciated.


India has taken an initiative towards Central Bank Digital Currency (CBDC) and shall introduce Digital Rupees to boost the digital economy. CBDC will be a legal tender and shall behave similarly to the currency issued by the Central Bank. This is a bold step taken by government of India by moving towards decentralization. It’s all digital and shall serve as a sovereign currency but in an electronic form appearing as currency in circulation on the balance sheets of central bank. Also, you are facilitated by the choice to exchange your CBDC for equivalent paper money. This will help India explore, innovate and advance in technology. According to economists, if India desires high growth rates, it’s important for Indian manufacturing industry to access global markets and value chains accommodating technological advancements and not by bypassing them. No official data is available in regard to the size of the Indian crypto market. However, as per estimates, there are 15-20 million crypto investors in India with total crypto holdings of around USD 5.34 billion.


Cryptocurrencies holds the potential to destabilize the Indian economy, to the extent of replacing it in both the domestic and international market. The dollar is becoming more expensive. In case of exports this might seem favourable but in case of imports, it shall cost heavily. Foreign equity investors on the other hand would favour strong currency and low interest rates as it will enhance the profits of the companies leading to higher returns - in dollar terms. Foreign Institutional Investments are allowed into India and their outflow from India cannot be controlled by policy makers and RBI’s role to govern the monetary system of the country be affected negatively. FII’s are stepping away from emerging markets because of inflation, higher interest rates, weak currency value, etc. Rupee slumps as foreign funds exit Indian markets. India’s current account deficit is 1.7% of the GDP, which is prone to get inflated, adding pressure on Rupee. Similarly, fiscal deficit can increase too, not favouring industrial growth. In the scenario of US raising its interest rates there will be a further outflow towards the US bonds market. As per Gita Gopinath (deputy Managing Director of International Monetary Fund), 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 US; reflecting the fact that only few countries use their own currencies for international transactions crediting the popularity of the dollar abroad. Also, research specialists suggest that Indian EXIM transactions are dominated by dollars. Cryptos are not restricted to the use of payment of goods and services, rather it can be exchanged for flat currencies and US dollar is mostly preferred for this.


Some cryptocurrency scams that need to be avoided are: Fake ICO’s (Initial Coin Offerings), Fake Bitcoin Exchange, Fraudulent Wallets, Ponzi Scheme (Pyramid Scheme), Phishing, Airdrop Scams, Pump and Dump, Malware Scams, etc. RBI officials caution that besides being used for terror financing, money laundering and drug trafficking, cryptos pose a greater threat towards the stability of the financial system of India because people may invest in such attractive assets (in cryptocurrencies), which may lead to the banks inability to lend money because of lack of resources. This will seriously undermine RBI’s capacity to determine monetary policies and regulate the financial system of the country. The central bank is hawk-eyed with high inflation, stagflation, devaluation of Rupee in this volatile market trends.  


Pic Courtesy: iStock