Is the US dollar's status as the world's reserve currency under threat?

The recent financial crisis and the US government’s response to it in terms of aggressive monetary and fiscal policies have led to the sharp weakening of US dollar. This has compelled central banks across the globe to rethink their decision of accumulating the US dollar as a foreign exchange reserve on their balance sheets. The concerns can be better understood when considering the vast reserve accumulation by emerging markets in recent years, a large portion of which is in dollar-denominated assets such as US Treasuries .

An understanding of why the central banks hold foreign currency as a reserve is important to better analyze the situation. The Central banks of any country hold reserves for three primary reasons: 1) they need a store of wealth that is relatively liquid, 2) a high level of financial reserves is important to inspire investor confidence and to deal with any foreign exchange turbulence, and 3) importing and exporting firms need to be assured of a ready supply of foreign currency.

In view of this consideration, a foreign reserve currency must possess the following characteristics: 1) It must be widely used as the currency of denomination in global trade and financial transactions, 2) must be highly liquid and fully convertible for both account and capital account purposes to ensure that reserves can be promptly employed at time of crisis and 3) its value must be relatively stable to other currencies.

The US dollar not only satisfies but also leads the fulfillment of these criteria as compared to its rivals. Firstly, the dollar is the principal unit of account used in global trade. This is mainly because of the large share of US in the global trade and also because of the third-country trades, priced in US dollars terms. This has continued despite the emergence of the Euro in 1999. This is primarily due to the liquidity and sophistication of the US and dollar-denominated commodities futures markets. Secondly, the dollar is the leading currency used in global finance, notably in the markets for international loans and debt securities .As of year-end 2008, the dollar accounted for more than half of cross-border loans and for 40% of outstanding debt securities globally. These shares have remained relatively stable throughout the period since the Euro’s launch in 1999. Thirdly, the dollar is the most liquid currency by far: According to Bank for International Settlements data, 86% of total foreign exchange turnover during 2007 involved the US dollar. The Euro came in a distant second with 37% of total foreign exchange turnover, while the Yen was further behind, with a 17% share. Fourthly, the US Dollar acts as a “vehicle” currency in foreign exchange markets, a use that reinforces its international role in trade and finance.

As per the facts stated above, the final verdict is that the dollar retains a clear lead as the currency of choice in global trade and finance. This means that it’s in the interest of central banks to continue to hold a large portion of their foreign exchange reserves in US dollars, given that a large share of their countries’ external obligations is denominated in dollars. Thus the status of US dollar as a reserve currency will prevail!

Indian Union Budget 2010 --- A review

--April,2010---


The Sensex is soaring new heights. The primary market is bombarded with a host of new issues. The mood across industries is upbeat. And most importantly, the “Aam Aadmi” is happy.
Has the Union budget 2010 really delivered more than what people wanted? Or is it that the expectations were low?
The Finance Minister has given a surprising gift to the common man in the form of significant expansion of income tax slabs by enhancing the threshold limit and removing the surcharge. As a result, a person earning Rs 5 lac would be Rs 20,600 richer than before. An additional tax saving tool was provided to the common man in the form of Infrastructure bonds. An investment of Rs 20,000 could be made over and above the Rs 1 lac limit under section 80 C. This would help boost the infrastructure development efforts in our country.
The wallet of “aam aadmi” has become thicker, but will the money sustain in this wallet. The excise duty has been increased from 8% to 10%. The 5% duty on crude petroleum has been restored. This will lead to an increase in the fuel prices. Fuel prices being hiked makes travelling costlier and the soaring rates of cars, electronics and jewellery leaves us sighing. The increase in these costs would increase inflation which would in turn affect the interest rates.
IT industry has given thumbs up to the Budget 2010 owing to the favorable response towards the Special Economic Zones (SEZs). However, they are disappointed over the extension of tax breaks under the Software Technology Parks of India (STPI) scheme. Surcharge for domestic companies reduced to 7.5% from 10%—largely positive. But on the other hand Minimum alternate Tax (MAT) hiked from 15% to 18%—negative for MAT paying companies. Rollout dates for the Goods and Services Tax (GST) and implementation of the Direct Tax Code is impressive. Though, we still can’t be certain. New banking licenses will be issued to NBFC’s. But this again will increase the competition for existing banks which are still fighting the downturn.
Government had provided the much needed fiscal simulation during the financial crisis largely through borrowed money. This has resulted in a large fiscal deficit of 6% in 2008-09. The government’s target is to reduce this to 5.5% in 2011-12 and to 4.8% subsequently. But how does our government plan to implement it? It plans to achieve this largely by funds from auctioning of 3G spectrums and disinvestment of its share in PSU’s. But both of these are just one shot items. What next?