An
RBI notification defines a permitted currency as one which is freely convertible.
In other words, currencies, which have full convertibility i.e., both on current
and capital account, can be considered permitted currencies for the purpose of
exchange control. The permitted currencies can be used for the purpose of invoicing
by customers and banks can also trade in these currencies. Currencies which are
used globally for international transactions are called international currencies
and when global usage is permitted, it is the internationalization of the currency.
The US dollar, euro, Japanese yen, Sterling, etc., are obvious examples of international
currencies. Some prerequisites for a currency to be internationalized are large-scale
of the economy of the currency, globalization of that economy, full convertibility
on current accounts and nil or negligible restrictions on convertibility on capital
accounts, acceptance and international credibility, both by trade and treasury
participants, well-developed markets to withstand any currency volatility, strong
banking system, enough depth in its trading, etc. A Central Bank willing to internationalize
its currency needs is to be well-equipped with implementing monetary policy to
face the challenge of currency volatility.
Dollarization
on the other hand is the use of a foreign currency for domestic transactions.
For example, keeping an Exchange Earners Foreign Currency (EEFC) account, say,
in Euro (not necessarily dollar) in India by a resident Indian entity or individual.
Thus dollarization is arrival of a foreign currency into a domestic scenario while
internationalization is the entry of the domestic currency into international
arena. In dollarization, there are foreign currency assets and liabilities held
by residents, while in Internationalization, there are domestic currency assets
and liabilities held by non-residents. Conceptually, both amount to Capital Account
Convertibility (CAC) of the currency.
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