One implication that is relevant to India is the impact this could have on remittances. Remittances make up close to 20% of El Salavador’s GDP with flows approximating $6 billion annually.
Written By Tanvi Ratna
El Salvador, a small coastal country in South America, on Wednesday became the first in the world to make Bitcoin, a digital currency, legal. The El Salvador Parliament approved the move by a supermajority of 62 out of 84. While there are many precedents this sets for global debate on cryptocurrency, we explore what this means in the Indian context.
Not a precedent for monetary policy
The development in El Salvador changes little in terms of Indian monetary calculations around cryptocurrencies. The dynamic underpinning the whole move is that El Salvador has no monetary policy of its own and hence, no local currency to protect. The country was officially ‘dollarized’ in 2001 and runs on the monetary policy of the US Federal Reserve.
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What is relevant to monetary thinking, however, is that the move in El Salvador is in part motivated by loose and expansionary Federal Reserve policy. While banks in the US received liquidity with the stimulus, El Salvador did not but lost purchasing power instead. The official bill proposal stated explicitly that “central banks are increasingly taking actions that may cause harm to the economic stability of El Salvador… (and) in order to mitigate the negative impact of central banks, it becomes necessary to authorize the circulation of a digital currency with a supply that cannot be controlled by any central bank and is only altered in accord with objective and calculable criteria,” i.e, Bitcoin.
President Nayib Bukele, however, clarified that he does not believe this constitutes “de-dollarization” of the economy. He believes the dollar will continue to remain the dominant currency in the country and Bitcoin would exist side by side. He also appeared skeptical that Bitcoin would be held in the reserves of the country. Indeed, some analysts have pointed out how bitcoinization might change nothing on ground if “legal tender” is to be considered by its strict legal definition, in which case it places no obligation for merchants to accept the currency in transactions. However, as a result of this development, El Salvador becomes a most interesting case study of how the dollar and bitcoin would coexist side by side, and how that would play out for Bitcoin adoption.
Not merely currency but technology
The overall use of Bitcoin appears less motivated by its use as a currency and much more by the image and investment boost this could give the country towards innovation. President Bukele reiterated multiple times in an appearance on Twitter today, that this move will be good for luring “technology, talent and new ideas” into the country. The President himself tweeted an advertorial to this effect, inviting crypto entrepreneurs into the country.
The move into Bitcoin ties in with larger efforts to revive a stalling economy and bring back growth into the country post-Covid. El Salvador had set up in 2020 a Trust Fund to support in its Covid recovery efforts. Interestingly, this same Trust Fund will house a $150 million national fund that will be used to buy and sell Bitcoin.
Potential shift in remittances
One implication that is relevant to India is the impact this could have on remittances. Remittances make up close to 20% of El Salavador’s GDP with flows approximating $6 billion annually. Many citizens lack a bank account and digital banking has low penetration. In this scenario, there are multiple intermediaries in the remittance chain who take cuts of as high as 20%. The impact Bitcoin has on these remittance inflows would be worth monitoring for India, which is home to the largest remittance market in the world. Although there might not be many lessons from a monetary policy perspective but efficiency, anti money-laundering and other aspects could be closely monitored.
The implication of this move for money laundering is unclear at the moment. Currently El Salvador is not considered deficient under the FATF money laundering requirements. However, with large scale cryptocurrency inflows and outflows, it would be expected that El Salvador would comply with the 2019 FATF guidance on Virtual Currencies which mandates multiple KYC requirements on cryptocurrency activity. It is unclear if these are in place in El Salvador or would be put in place. It could be that the country faces challenges on this front unless there is a rapid push to put in place the necessary oversight measures.
The overall takeaway for India from the El Salvador case is not in the monetary sense at all but as an example of how far countries are willing to go to attract what they believe is the ultimate prize – innovators and entrepreneurs working on this emerging sector. This is the wealth that India has in spades and has barely protected with policy. While deliberations continue in India on the monetary and financial regulations around cryptocurrency, it is important that attention be paid to incentives for India’s developers working on key innovations in the space.
Tanvi Ratna is Founder & CEO, Policy 4.0, a think tank focused on the future of money and emerging technology issues for India
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