The Reserve Bank of India (RBI) has introduced a mechanism to facilitate international trade in rupees. Now the import and export payments may be settled through a special Vastro account, while the banks with prior approval from the RBI can act as authorised dealers for such transactions. There is no doubt that this is a great step in the right direction considering the limitation of using the US dollar as the medium of international transactions, especially with counties under sanctions. This would also help reduce exchange rate risk on traders and pressure on the Indian rupee.
Currently, global trade and the economy are going through difficult times, especially after the Covid-19-inflicted recession and the renewed geo-political tensions in Easter Europe. Many developing countries in Asia, Africa and Latin America are on the verge of currency crises with severe foreign exchange shortages and volatility. Higher imported inflation and interest rate are in fact pushing these economies into a state of stagflation. At this juncture, an alternate arrangement to US dollar-based settlement system with one using INR would bring a win-win situation to both the partner countries in trade.
When the RBI floated the circular on this, there were wider discussions on internationalisation of the Indian rupee. Although this can be termed as a step in this direction, the internationalisation of the rupee requires a number of short-term and long-term actions.
An international currency is one that is used instead of the national currencies of the parties directly involved in an international transaction, whether the transaction in question involves a purchase of goods, services, or financial assets. Invoicing of merchandise trade (over-the-counter (OTC) and organised exchanges), including in trade between third countries; use of currency in the capital market, both national as well as international, where foreign investors are the major players, are certain immediate aspects of internationalisation.
As per the latest Triennial Central Bank Survey, US dollar accounts for 88.3% of global foreign exchange market turnover, followed by Euro, Japanese Yen and Pound Sterling with a major share, while the Indian rupee accounts for 1.7% underlining the need for pushing the currency much farther to get an international tag.
It is true that gradual currency internationalisation may happen with an increased share in international trade. However, in order to push the currency international so as to reap the benefits of trade and investments, multiple and concerted steps from the government and the regulators are important. Some of them include the removal of restrictions on buying and selling of domestic currency in both spot and forward markets; domestic firms are able to invoice exports and imports in their own currency; foreign firms, financial institutions, government institutions and individuals are able to hold the country’s currency and financial instruments; foreign firms and financial institutions, and government institutions are able to issue marketable instruments in the country’s currency; country’s own financial institutions and non-financial firms are able to issue on foreign markets instruments denominated in their country’s own currency; international financial institutions, such as the World Bank and regional development banks, are able to issue debt instruments in a country’s market and to use its currency in their financial operations; and the currency may be included in the “currency baskets” of other countries, which they use in governing their own exchange rate policies.
As far as the Indian rupee is concerned, our currency is fully convertible in the current account i.e., conversion mainly for trade in goods and services, but partially in the capital account i.e., conversion for the purpose of moving capital across the border. Here it would be interesting to look at the position of the Indian rupee against the points discussed in the above paragraph, which will acknowledge why the rupee is partially convertible in the capital account. In fact, India has already come a big way in capital account convertibility, but with very cautious and gradual steps. Although we opened up our economy for portfolio and direct investments, experience from East Asian crisis and other major currency crises have taught us to avoid any radical step in this direction. This may be remembered that the idea of issuing foreign currency sovereign bonds which were highlighted by the Finance Minister in one of her budget speeches was still not actioned upon.
Some of the benefits of internationalisation of the rupee would include limited exchange rate risk for traders in goods and services, access to international financial markets for cheaper capital by domestic firms and institutions without incurring exchange rate risk, and wider business opportunities in global capital markets for domestic financial institutions. On the government side, this may give more options to meet their budgetary deficit while the issue of the current account deficit can be addressed without drawing down the official reserves.
As regards the cost is concerned, internationalisation of currency will limit the country’s ability to anchor monetary policy to its domestic economic landscape and have a fixed or highly managed exchange rate regime. Domestic currency may also be prone to wider fluctuations and depreciation as the overseas investor sentiment will have wider ramifications on the currency when a sizeable portion of currency and instruments are held overseas. Other than the above, the issuance of foreign debt in the domestic market may pose risk especially when the debtor default. Most financial crises, if it is the crises 1980s or 1990s or 2008, are testimony to the cost involved.
Overall, currency internationalisation is a double-edged sword with the ability to hurt if we are not prepared well but has immense potential. As a growing economic powerhouse, wider use of local currency with fewer barriers will help support international trade and investments. The recent initiative of invoicing trade in rupee comes from a different global requirement and order, but for true internationalisation and wider use of rupee overseas, opening up of trade settlement in rupee alone will not suffice. Further opening up and liberalised settlements in the Indian rupee for various financial instruments both in India and overseas markets are more important. The promotion of rupee-based settlement in both international trade and financial markets would also attract more global players to go for this option as the world is moving towards a multi-polar system where India will be a dominant power. A strong foreign exchange market with an efficient swap market may be another precondition for rupee internationalisation. Further improvement in overall economic fundamentals, and financial sector health, followed by an upward movement in sovereign ratings would also strengthen confidence in the Indian rupee, making the currency ready for the next step in its international journey.
(The writer is Director, Centre for Economics and Finance, Administrative Staff College of India (ASCI) Hyderabad)