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The memorandum of understanding signed by the Central Bank of the United Arab Emirates and the Reserve Bank of India to establish a framework to promote the use of local currencies – UAE dirham and Indian rupee – may sound simple, but it is disruptive and transformative. The framework intends to establish the “Local Currency Settlement System”.
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In simplified terms, it is an effort to establish a localised trading system, or bloc, in which each country pays with its own currency. It entails abandoning the dollar as an international medium of exchange. Indirectly, the dollar has adopted the status of a standard currency, similar to the defunct gold standard. There were both positive and negative factors why the US dollar became the arbitrator of currencies.
The United States was an economic titan. It was purchasing products from everywhere, and when purchases were made in dollars, exporting countries benefited greatly due to the dollar’s higher value, which was supported by a robust economy.
The United States was also a leading economic power because it holds the largest stake in the World Bank and the International Monetary Fund (IMF). The dollar was the dominant currency because the United States dominated the international economy. The United States is now a declining economy as well as a declining global power.
Even though their economies are very different, it is not strange that India and the UAE, two countries with growing economies, want to change the rules of trade between them by using their own currencies instead of the dollar.
There were two ways for them to choose the money they would use to trade. The dirham was stronger than the rupee, so it could have been the dirham. In fact, the dirham became a sort of unofficial global currency when Russian oil imports after the war in Ukraine were paid for in dirham instead of dollars because Western bans didn’t allow trade in dollars.
But India has a much bigger economy, so Dirham would not have been a good bargaining chip for the amount of trade between the two countries. To become the centre of payments, the rupee, and the dirham had to be paired as currencies.
With this new plan, there would be no world currency of reference, and each currency would have to figure out how much it is worth in terms of every other currency. It’s a breakdown of a world trade system based on a single currency.
It means the end of globalization, where a uniform system made it easy for things and money to move around. India and the UAE are not trying to do any of these big things in terms of world trade and money. They seem to think that if everyone paid in their own currency, it would be much easier to do business with each other.
But what the UAE really wants is for the dirham to become a world currency because its currency is trusted because it comes from a wealthy country. India also hopes that the rupee will get stronger as the country’s economy grows and moves up in terms of how much it can buy and export and how big it is.
But right now, India and China, two of the world’s biggest countries, are not yet import-friendly. Like the Asian Tigers of the 1980s, they focus on exports. The UAE is not afraid of imports, but it only has a limited amount of space to take in imports.
Money theory can be hard to understand when it comes to exchange rates. In the real world, though, it works in a much easier way. The dollar is the most popular coin because it can buy more than it can sell. This is why the dollar has the best exchange rate. When Americans can’t buy as much, the dollar loses its power. In a way, the plan to use local currencies in trade between India and the UAE is a “test of the waters” to see which of the two currencies could become the world’s most important one.
National goals are hiding in the background. There is also a chance that the easiest way to deal with the regionalization of world trade is to deal with the currencies of each country. India and the UAE might want to add more countries that use their own currencies in international trade.
India and Indonesia are already working on a deal like this. Will it work out? The road is hard because having political power is just as important as having money. India and the UAE don’t have as much political power in the world yet, and even though their economies are “emerging,” they aren’t as strong as the Chinese, American, European, or Japanese ones.
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