22 Oct

Internalization of Rupee

< General Studies Home Page 

Contents

• What is Internationalization of Rupee?
• Advantages of Internationalization of Rupee
• Internationalization of currency is closely linked with a nation’s economic progress
• Steps Taken towards Internationalization of Rupee
• Challenges in achieving internationalization
• Recommendations given by RBI’s Inter-Departmental Group

---

What is Internationalization of Rupee?

Internationalization is a process that involves increasing the use of the rupee in cross-border transactions. It involves promoting the rupee for import and export trades, and then other current account transactions, followed by its use in capital account transactions.

It will also require:

• Full capital account convertibility (currently India allows only full current account
  convertibility, capital account convertibility is limited).
• Availability in sufficient quantities
• Opening up of currency settlement and a strong swap and forex market.

Advantages of Internationalization of Rupee:

• Reduces exchange rate risks, while curtailing the demand for US dollar.
  • This not only promotes ease of doing business but also improves the chances for Indian businesses to grow globally.
  • Reduces the need of forex war chest to meet the external vulnerabilities.
  • Reduces risk to economy due to sudden withdrawal of capital from market.
  • Lower cost of capital due to better access to international financial markets.
  • Bargaining power of Indian businesses will increase, adding weight to Indian economy and enhancing India’s global stature and respect.
  • Reduced transaction costs: They will not have to incur exchange rate fees.
  • Geopolitical Significance: US-dollar dominated global currency system can become limitations for the economy if India’s relations with US and Europe becomes tense in future. In that scenario, business in domestic currency can be a savior.

Internationalization of currency is closely linked with a nation’s economic progress.

• Currently, the US $, the Euro, the Japanese Yen and the pound sterling are the leading reserve currencies in the world. China’s efforts to make its currency renminbi (yuan) a reserve currency has met with only limited successes so far.
• US$ is said to enjoy an ‘exorbitant privilege’, which refers to the innumerable benefits that accrue to the US on account of all other countries of the world using the US$ as their currency in most of their international transactions, among global currencies.
• Factors behind US$ being the most common currency of reserve and exchange:
  • Size of US Economy (largest in the world)
  • Reach of its trade and financial market
  • Depth and liquidity of the US financial market
  • History of macro-economic stability
  • Currency convertibility
  • Lack of viable alternative.
• Is there are challenger to US dominance?
  • The obvious challenger to US dominance is the Chinese Renminbi. However, it ability to rival the US dollar will depend on future policies in both the US and China and the ability of Chinese economy and its financial system to demonstrate long term resilience, integrity, transparency, openness and stability.

China’s Experience:

• Before 2004, RMB couldn’t be used outside China.
  • By 2007, the “Dim Sum” bond and offshore RMDB bond market had been created.
• Post 2008, China pursued a phased approach.
  • First, it allowed use of RMB outside China for Current account transactions and for select investment transactions (FDI, outward direct investment) etc.
  • By 2009, it had signed currency swap agreements (i.e., an exchange of an equivalent amount of money, but in different currencies) with countries like Brazil, UK etc.
  • Then, Central banks, offshore clearing banks and offshore participating banks were allowed to invest excess RMB in debt securities.
  • Sanghai Free Trade Zone was launched in 2013, to allow free trading between non resident onshore and offshore accounts.
•  In this way, overtime RMB was internationalized, with reserve currency status increasingly enabled. For e.g. in Q2, 2022, the RMB’s share of international reserves had reached around 2.88%.

Steps Taken towards Internationalization of Rupee:

• Liberalization of Capital Account: Over the years, government has relaxed FII and FDI norms, facilitating greater cross-border investment and trade.
• Enabling of ECB in rupee.
• Currency Swap Agreements with several countries, which allow for the exchange of rupee and foreign currency between the central banks of the two countries.
• RBI allowed banks from 18 countries to open Special Vostro Rupee Accounts (SVRAs) for settling payments in Indian Rupees.
• RBI constituted Inter-departmental group (IDG) headed by RBI Executive Director Radha Shyam Ratho to frame roadmap for the Internationalization of Indian Rupee has submitted its report.
• During PM Modi’s visit to UAE in July 2023, Reserve Bank of India (RBI) signed two MoUs with Central Bank of UAE. One of the MoU focuses on establishing a framework to promote the use of local currencies from cross-border transactions, the other was for linking payment systems.

Challenges in achieving internationalization:

• Little traction for international trade in rupee:
  • The daily average share of Rupee in the global foreign exchange market hovers around 1.6%, while India’s share of global goods trade is around 2%.
    • For e.g. Russia reportedly preferred Yuan or Dirham as a medium of transaction for Indian imports of oil, rather than rupee.
• Large Trade Deficit: It would make acceptance of Rupee in global economy would be limited due to its depreciation problem.
• Lack of Liquidity: For now, Indian rupee is not as liquid as other major global currencies and thus it may be difficult to buy and sell large amounts of rupees.
• Underdeveloped Financial Markets: India’s financial market are still relatively under-developed when compared to major economies, which can limit the range of products and services available to international investors.
• IDG has also highlighted following limitations that may arise due to internationalization of Rupee:
  • Exchange rate volatility in rupee’s exchange rate will increase in initial stages of
    internationalization.
  • Triffin Dilemma: Obligation of a country to supply its currency to meet the global
    demand may come in conflict with its domestic monetary policies.
  • Accentuation of external shock may take place due to open channel of flow of funds into and out of the country and from one currency to another.
• However, the IDG itself said that the advantages of internationalization far outweigh the above limitations. Moreover, the internationalization of rupee will be a long drawn process and would enable timely redressal of these challenges.

Recommendations given by RBI’s Inter-Departmental Group:

• Short term measures:
  • Adoption of Standardized approach for examining the proposals on bilateral and
    multilateral trade arrangements for invoicing, settlement, and payment in the rupee and local currencies.
  • Encouraging the opening of the rupee accounts for non-residents both in India, and outside India.
  • Incentivizing exporters to use Indian currency for trade settlements.
  • Integrating payment systems to provide seamless cross border transactions.
  • Strengthening the financial markets by fostering a global 24X5 rupee market
  • Recalibration of FPI regime.
• Medium Term Measures (2-5 years targets)
  • Synchronizing tax regimes of India and other financial centres.
    • A review of taxes on masala bonds
  • Allowing banking services in the rupee outside the country
    • Allowing international use of RTGS for cross border trade
  • Inclusion of Indian government bonds in global bond indices
• Long Term
  • Measures to have rupee included in the IMF’s SDR.

Other steps that can be taken:

• Focus on increasing exports – As India increases exports and accepts money in rupee, it will lead to more acceptance of rupee internationally.
• Rupee should be made fully convertible – letting financial investments move freely between India and abroad.
• Deeper and more liquid rupee bond market – This will allow foreign investors and Indian trade partners to have more investment options in rupees, enabling its international use.
• Additional Currency Swap Agreements (as with SL) would further allow India to settle trade and investment transactions in rupees, without resorting to a reserve currency like dollar.
• Tax incentives to foreign businesses to utilize rupees in operations in India would also help.
• Currency Management Stability: RBI and Finance Ministry has to ensure currency management stability through consistent and predictable issuance/retrieval of notes and coins).
• Improvement in general macro-economic parameters – The Tarapore Committee’s
  recommendations must be pursued including a push to reduce fiscal deficits lower than 3.5%, a reduction in gross inflation rate to 3%-5% and a reduction in gross banking NPAs to less than 5%.

Conclusion:
As the Indian economy grows in size, as its trade linkages with other countries grow stronger, more space will be created for using the rupee in international transactions.

Example Questions:

• Discuss the major challenges and obstacles faced by the Indian Rupee in achieving
  internationalization and becoming a global reserve currency. [15 marks, 250 words]
• Discuss the key advantages and disadvantages of having the Indian Rupee as an International currency for cross-border transactions [10 marks, 150 words]