The Hindu Business Line : Dollar's drop

IN THE PAST three years the dollar has depreciated by more than 40 per cent against the euro and by almost as much vis-à-vis the yen and the pound. The dollar's pre-eminence in the international financial system after the Second World War was due to a number of factors. It was the only currency of reserve and favoured by all central banks to park their reserves. And in trading rooms all currency quotations are benchmarked to the dollar.

The strength of the US economy and the geo-political influence that the country wielded gave the dollar its exalted status. With the US Treasury undertaking to convert dollars into gold at a fixed rate, under the Bretton Woods agreement, central banks the world over could have an indirect link to a gold standard by merely pegging their currency to the dollar. And even after the US Government unilaterally disbanded this arrangement in 1971, the dollar continued to reign supreme as much of global trade, irrespective of its origin and destination, remained dollar denominated. Commodities having a strategic significance especially petroleum and petroleum products are invariably invoiced in dollars.

For India, too, the dollar has been the preferred currency. The Reserve Bank of India keeps a substantial portion of the country's $140-billion reserves in dollars and dollar-denominated assets. A very large portion of imports and exports continues to be invoiced in dollars, despite the emergence of other options. Most of the country's external borrowing has been in dollar. Practically all remittances, which more than merchandise trade has propped up the current account, are dollar denominated. However, as elsewhere in the world, concerns are being heard in India too as to how enduring the dollar links will be. There can be no two opinions that the dollar's recent fall — and the seemingly unconcerned attitude of the American government — has raised questions over its role as the preferred currency for holding reserves and in trade-related matters. Recent statistics of the Bank of International Settlements indicate that the RBI and its Chinese counterpart have started shifting a portion of their reserves away from dollars and into euros.

Obviously, the rise of the euro is an important factor to be reckoned with in any discussions on the future of the global monetary arrangements. After overcoming all its handicaps, the euro can now lay claim to the status of a reserve currency. For instance, there is a deep bond and debt market in euros capable of absorbing the world's reserves, should central banks decide to shift out of dollar. No doubt the economic well being of the Euro Zone helps but at this point it seems highly unlikely that the euro will displace the dollar as the world's premier currency any time soon. Those who see parallels between the fall of the pound sterling (after the First World War) and the earlier demise of the gold standard on the one hand and the current predicament of the dollar, on the other, may be wrong, for now at least.

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