On July 5, 2023, a working group sanctioned by the Reserve Bank of India put forth a series of proposals aimed at internationalisation of the rupee. Key recommendations include the incorporation of the rupee into the Special Drawing Rights (SDR) basket and the overhaul of the foreign portfolio investor (FPI) framework.
These bold strides have been put forth with the goal of expediting the rupee’s internationalisation.
- The recommendations, formulated by an Inter-Departmental Group (IDG) led by RBI Executive Director Radha Shyam Ratho, were published on the official RBI website.
- RBI Deputy Governor T Rabi Sankar formed a committee to evaluate the status of the rupee as a global currency and develop a roadmap for promoting the international usage of the domestic currency.
Internationalisation Of Rupee
The internationalisation of the Rupee refers to the increasing use of India’s domestic currency in the realm of cross-border transactions. Essentially, the process is characterised by a growing number of international payments being conducted in Indian Rupees.
This expansion is primarily driven by the promotion of the Rupee in current account transactions and foreign commerce. Such transactions necessitate interaction between resident Indians and non-residents, further bolstering the international presence and recognition of the Rupee.
What sets internationalisation apart from paying in rupees while abroad?
Internationalisation of the Indian rupee entails its predominant use in international trade and cross-border transactions. Nonetheless, when the Indian currency is used for payments and purchases in foreign countries, it does not signify true “internationalisation.”
Also Read | What Is An International Currency?
What Will Happen With The Internationalisation Of The Rupee?
- This will reduce the currency risk of Indian businesses by protecting them against currency volatility.
- It will also reduce the need to maintain foreign reserves, making India more insulated from external shocks.
- It will also provide India with higher bargaining power in international markets.
- The internationalisation of the Rupee could further boost India’s economic clout on the global stage. With transactions becoming more direct without the need for currency conversion, Indian businesses can achieve smoother and more cost-effective operations internationally.
IDG’s Recommendations On Internationalisation Of Rupee
RBI’s Inter-Departmental Group (IDG) has made following recommendations for internationalising Indian Rupee.
- Due to India’s rapid growth and impressive resilience in challenging times, the rupee has the potential to emerge as a globally recognized currency. As one of the fastest growing countries, India’s currency holds promise on the international stage.
- Higher use the rupee for invoicing, international trade settlement, and capital account transactions will gradually bolster the prominence of the rupee on the global stage.
- In July 2022, the RBI implemented a mechanism to facilitate international trade settlements in rupees. This initiative aims to foster global trade growth, with a particular emphasis on boosting exports from India. Additionally, it supports the growing interest of the global trading community in conducting transactions using the rupee.
- While the country has had ongoing rupee arrangements with Bhutan and Nepal for a significant period, Sri Lanka’s recent decision to officially include the rupee as a designated foreign currency signifies a positive step towards the gradual internationalisation of the domestic currency. This development bodes well for enhancing the overall standing and acceptance of the rupee in the global arena.
- To facilitate the internationalisation of the rupee, the group proposed the incorporation of the rupee into the Special Drawing Rights (SDR) basket.
- Suggesting short term measures, the group said a standardised approach or /uniform template should be adopted for examining all proposals that involve bilateral and multilateral trade agreements/arrangements for invoicing, settlement and payment in the rupee and local currencies of counterpart countries, local currency settlement mechanisms and bilateral swaps.
- It is advisable to utilise established bilateral and multilateral payment and settlement mechanisms, such as the Asian Clearing Union (ACU), to promote the global acceptance of the rupee.
- Allowing non-residents to open rupee accounts is a crucial step towards internationalising the currency. The ability to open accounts beyond the borders of the currency’s home country serves as a fundamental pillar in achieving this goal.
- The Reserve Bank of India (RBI) should also consider broadening the reach of the rupee-based payment system, enhancing its accessibility and convenience for users.
- The Reserve Bank of India (RBI) should take proactive measures to ensure the inclusion of Indian Government Bonds (IGBs) in global bond indices. Additionally, it is recommended to streamline the Foreign Portfolio Investment (FPI) regime, fostering a more favourable environment for foreign investments in both the Indian government and corporate debt markets.
- In the medium term, the group suggests reviewing the withholding tax for masala bond issuances, expanding the Real Time Gross Settlement (RTGS) system for international transactions, and including the rupee in the Continuous Linked Settlement (CLS) system.
What Does Internationalisation Of Rupee Require?
IDG has highlighted the following preconditions for internationalisation of rupee.
Capital Account Convertibility (CAC)
The free movement of capital, also known as the internationalisation of capital markets, is widely acknowledged as a catalyst for economic growth. Internationalised capital markets offer a range of well-established advantages, including but not limited to the following:
- Broadening the investor base for country’s financial assets
- Improve liquidity in the domestic financial markets.
- Induce positive pressures for market infrastructure and market practices.
- Enable access to a global savings pool thereby reducing borrowing costs.
- Facilitate better risk allocation and enhance global liquidity.
The IDG underlines that bolstering these factors is essential for the internationalisation of the INR, much like it is necessary for comprehensive Capital Account Convertibility (CAC). However, the group contends that having a fully convertible capital account isn’t a prerequisite for the INR’s internationalisation, or vice versa, as evidenced by Renminbi’s example.
The IDG believes that it is possible to achieve a significant level of currency internationalisation, even without full capital account convertibility.
Liquidity In INR/Local Currency
To foster global use of the Indian Rupee (INR), it’s essential that adequate liquidity of the INR is maintained at both national and international central banking levels. This ensures that stakeholders, economic actors, and participants in the market have the necessary confidence to handle cross-border transactions using the INR.
The global financial landscape has recently experienced a surge in monetary exchanges, which has led to heightened instability in the foreign exchange (forex) markets. Events such as the COVID-19 pandemic and the conflict in Ukraine have amplified this volatility, sending ripples through the external sector and inciting instability in both the macroeconomic framework and the financial sector.
This instability is particularly pronounced in emerging market economies (EMEs), which bear the brunt of these monetary shocks.
To effectively handle such volatility and mitigate associated risks, the IDG suggests that policymakers consider utilising local currency settlement mechanisms and local currency swap arrangements. This approach can help reduce reliance on convertible currencies for cross-border trade transactions and payment obligations.
Local currency settlement offers a method of diversifying currency holdings, thereby providing a protective measure against potential risks related to currency fluctuations. It reduces transaction costs by implementing direct exchange rates, which are typically more efficient. Moreover, it speeds up the process of transferring payments.
Likewise, local currency swaps can serve as a vital instrument in mitigating and controlling financial risks by enhancing liquidity in both the recipient country and the domestic banking sector.
Strong Cross-Border Payment System
Implementing a strong rupee-based cross-border payment mechanism is a vital step towards the global acceptance of the Indian Rupee. This infrastructure enables swift and efficient inter-bank transfers and settlements for international transactions, ensuring a smooth flow of operations in local currencies.
One of the key advantages of such an infrastructure is the potential reduction in transaction costs. Further, it may also lessen our reliance on the SWIFT-based international payment systems, offering a more independent and secure solution for global transactions.
IDG has put forth a suggestion to utilise India’s sophisticated payment mechanisms, namely Real Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT), and Unified Payments Interface (UPI), for the rapid internationalisation of the Indian Rupee (INR). These systems, recognized for their potential worldwide, could be pivotal in expanding the global presence of the INR.
The IDG has conducted a study on the collaboration between the RBI and the Monetary Authority of Singapore (MAS) in linking their fast payment systems, UPI and PayNow respectively. The study supports the idea of pursuing similar projects with other countries, highlighting the need for further international cooperation in this area.
Recent Initiatives
In recent times, several initiatives have been implemented to foster the internationalisation of INR. These measures encompass, among other things:
- allowing issuance of offshore Rupee-denominated ‘masala’ bonds;
- allowing domestic banks to freely offer foreign exchange prices to non-residents at all times, out of their Indian books, either by a domestic sales team or through their overseas branches;
- allowing Rupee derivatives (with settlement in foreign currency) to be traded in International Financial Services Centers (IFSCs); and
- an additional arrangement for invoicing, payment and settlement of export/import in INR has been enabled vide circular dated July 11, 2022.
Understanding Special Drawing Rights (SDR)
Special Drawing Rights, often abbreviated as SDR, is an international monetary reserve established by the International Monetary Fund (IMF). It was designed to serve as a supplemental reserve for IMF member countries’ official reserves. The worth of SDR is derived from a weighted average of five major currencies, which are the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.
Presently, the dominant reserve currencies globally are the U.S. dollar, the euro, the Japanese yen, and the British pound sterling. Meanwhile, China is making efforts to expand the international reach of its currency, the renminbi, but these efforts have yet to bring about significant results.
Fascinating Facts About The Indian Rupee
Did you know that until the early 1970s, the Indian rupee served as the official currency in several Gulf countries, including Kuwait, Bahrain, Qatar, and the UAE? A unique arrangement was made in 1959, permitting the Reserve Bank of India (RBI) to circulate specially marked notes solely in the Gulf area. These notes had the same face value as the Indian rupee.
Interestingly, Indian citizens making the sacred pilgrimage to Haj were allowed to carry Indian rupee notes, which could be exchanged freely for Saudi riyals. In response to this practice, the Centre later produced unique “Haj notes” with the word “HAJ” imprinted on them.
However, a shift occurred in 1966 when the Indian rupee was devalued, leading many Gulf countries to discontinue the use of the Gulf rupee. By the dawn of the 1970s, the Gulf rupee had been phased out entirely as the official currency of these countries.
Opportunities
As the world transitions towards a multi-polar system, India is poised to become a commanding presence. This shift opens up avenues for the internationalisation of the rupee in trade and financial markets, and is anticipated to draw more global participants.
Recent geopolitical events, such as the Russia-Ukraine conflict, present unique opportunities for India. The resulting payment interruptions could pave the way for rupee-based settlements with some of India’s smaller export partners.
The internationalisation of the rupee is further bolstered by a robust foreign exchange market and an effective swap market.
Additionally, enhancing the overall economic fundamentals and health of the financial sector could boost sovereign ratings. This upward trend would instil greater confidence in the rupee, priming it for the next phase of its internationalisation journey.
Challenges
The internationalisation of the Rupee is a complex matter that brings with it several challenges. To begin with, the Rupee only represents a mere 2% of the global exchange market, which emphasises the necessity for a more aggressive approach to gain international recognition.
Furthermore, India’s net International Investment position – the difference between total external assets and total external liabilities – remains in the negative, indicating a deficit of $374.5 billion as of December 2022.
More than 80% of India’s exports are billed in dollars, while approximately 10% are in euros. When it comes to imports, these two currencies account for just over 90% of the total. Use of the rupee, on the other hand, is minimal.
A key indicator of currency internationalisation is the scale and makeup of the foreign exchange and corresponding Over the Counter (OTC) derivatives market. Despite India’s ranking around 20th in terms of turnover, it does have a significant presence in the non-deliverable forwards (NDF) market, a market distinct to emerging economies with capital controls.
In the realm of foreign currency reserves, the dollar remains dominant, making up over two-thirds of all countries’ forex reserves. The Euro follows at one-fifth, while the remaining currencies, excluding the British pound and Japanese yen, make up less than 10%. The Rupee is held in the reserves of a mere six out of 130 countries, whereas the ‘big four’ currencies – the dollar, euro, yen, and pound sterling – are held by over 100 of the 130 countries.
Lastly, the overall benefits of currency internationalisation do not provide a convincing argument for India to rush the internationalisation of the Rupee. Instead, the internationalisation of the Rupee is expected to be a result of continual development of the financial system and enhanced economic performance.
Way Forward
In conclusion, the path to Rupee internationalisation is a complex and lengthy journey. The transition won’t occur overnight and requires a solid foundation of economic stability, well-developed financial markets, and the global community’s faith in the currency’s long-term value.
While India has made notable strides in recent years, it must continue to improve its regulatory, institutional, and infrastructure frameworks to facilitate this transition. Therefore, the focus should remain on nurturing and strengthening these aspects, and Rupee internationalisation will inevitably follow as a byproduct of these developments.