Why the Central Bank Fears Dollarization Due to Cryptocurrencies

Cryptocurrencies can cause 'dollarization of the Indian economy,' RBI officials reportedly told a parliamentary panel

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Top officials of the RBI have told a parliamentary panel, according to news reports, that cryptocurrencies can lead to "dollarization" of a part of the economy which would be against India's sovereign interest.

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The Parliamentary Standing Committee on Finance, chaired by former minister of state for finance Jayant Sinha and top officials of the RBI, including governor Shaktikanta Das, reportedly expressed that cryptocurrencies pose challenges to the stability of the financial system.

"It will seriously undermine the RBI's capacity to determine monetary policy and regulate the monetary system of the country," a member of the panel was quoted as saying in a PTI report.

The Finance Minister had also said recently at a panel discussion organized by the International Monetary Fund that cryptocurrencies can be used for money laundering and terror financing operations. "I think the biggest risk for all countries across the board will be the money laundering aspect and also the aspect of currency being used for financing terror," she said.

The government implemented a 30 per cent crypto tax on digital asset holdings and transfers on April 1. It also announced many other stringent taxation guidelines that were based on gambling and lottery ticket win tax rules. This led to around 70 per cent decline in trading volume on top Indian crypto exchanges in a few days.

Now, the RBI officials have told the members that as almost all cryptocurrencies are dollar-denominated and issued by foreign private entities, it may eventually lead to the dollarization of a part of our economy which will be against the country's sovereign interest.

What is dollarization and how it can affect an economy

Dollarisation happens when dollars are used in addition to or instead of the domestic currency of a country.
Basically, when a country's own currency loses its usefulness as a medium of exchange, due to hyperinflation or instability, it leads to dollarization.

For instance, hyperinflation has led to large transactions in dollars in Venezuela and according to a Reuters report, this shift to the U.S. dollar or dollarization is widening inequality between its public and private sector workers. Two-thirds of dollars are held outside the United States.

When complete dollarization happens, a country stops to take decisions and influencing its economy. The country loses its right to administer monetary policy. Also, when a country becomes a fully dollarized economy, its central bank cannot act as a lender of last resort and also the securities will have to be brought back in US dollars.

And, as RBI officials mentioned, almost all cryptocurrencies are dollar-denominated and issued by foreign private entities, which it fears could lead to the dollarization of a part of our economy.