Rupee going global?

In recent years, two things have gotten traction: one, de-dollarization, and the potential rise of regional or alternative currencies for international trade and commerce. Among all the regional currencies, there has been much talk about the potential rise of the Indian rupee, encapsulated in the catchy words ‘Internalization of the Indian rupee’, as India seems to have changed its economic trajectory by way of being more assertive on the world stage.

Among the cross-section of intellectuals, there has been a debate going on about the possibility of the same. With the 2nd World War, the whole world has seen a tidal rise of the US dollar, with international institutions such as the IMF and the World Bank playing an important role in asserting the dollar’s hegemony across the whole world.

This hegemony is said to have given centre stage to the US in terms of controlling the political economy of every country, thereby leading to an era of Americanization of world politics. In 1944, with the Bretton Woods agreement, it was decided that every currency has to be pegged to the US dollar for the international flow of goods and services.

Two institutions were created to smoothen the institutional process of the whole project: the IMF and the World Bank. The allies paid gold to the US in return for US dollars, which made it the largest holder of gold reserves in the world. Most of the forex was kept in US dollars. However, very recently, we have seen that the demand for it as a reserve currency has overall declined. In 1999, 70% of world forex was kept in US dollars, which reduced to 55% in 2022, which has come to be known as dedollarization.

The concept became famous after the Russia-Ukraine war broke out in February 2022, when all of a sudden the US removed seven Russian banks from the Swift mechanism and Russia was barred from using its forex, kept in US dollars, which revealed the insecurity of the international financial system. Following the trend, in July 2022, the Reserve Bank of India allowed other countries to open special Vostro rupee accounts for trade invoicing in local currencies so that they do not become susceptible to the risks of a unilateral financial system.

These accounts enable banks to provide international services to their clients. In a written reply, the Union minister of state external affairs, Rajkumar Ranjan Singh, said that the rupee has received acceptance from such countries as Belarus, Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, New Zealand, Oman, Russia, and Singapore. Sri Lanka, Tanzania, Uganda, Bangladesh, the Maldives, the UK, the Seychelles, Kazakhstan, etc. But what benefits does an international currency confer on a country? This has to be answered.

Let’s say trade is to happen between India and the UEA. In that case, the rupee has to be converted to US dollars and then to dirhams, which bears a conversion fee and hedges against currency fluctuations. Why is India pushing for the same? India’s trade deficit has been huge due to its overt dependence on imports to meet its energy requirements.

Rupee depreciation, net imports due to the pandemic recovery, and the flight of foreign portfolio investment in the wake of the gross fiscal deficit are the other reasons why the government is focusing on rupee internationalization. Exchange rate risk would eventually reduce. According to Sri Lankan banking experts, the two countries would save 50% in transaction costs while trading in the Indian rupee rather than clearing payments through a bank in the USA.

India would wind up saving around $30 billion in dollar outflows if all its Russian imports were paid in rupees (report).

In December 2021, the RBI constituted an interdepartmental group, which gave both short-term and long-term suggestions as to how to get closer to the target of making the rupee an international currency.

Various short-term measures suggested included: enabling the rupee as an additional settlement currency in existing multilateral mechanisms; integrating India’s payment system with other countries for cross-border transactions; and providing incentives to exporters for rupee trade settlement.

On the other hand, various long-term steps include a review of the tax on masala bonds, harmonizing the tax regime in the country, allowing banking services outside, etc. The group came to the conclusion that it has the potential to be an international currency. Various reality checks need to be given to see how plausible the argument is.

 Challenges and a reality check: There are various challenges to the rupee becoming an international currency. The first challenge is the convertibility of the capital account. Free conversion allows for the free flow of goods, services, and other financial instruments. India allowed full convertibility on the current account in 1994, which allowed the flow of current account items such as goods, services, etc.

But it has not gone for a full convertibility on the capital account; instead, it went for a partial convertibility on it, which meant that there would be no free flow of capital account instruments in and out of the country, such as bonds and loans. There would be regulations put in place by the government of the country to protect the country against any financial risk. Full convertibility depends upon the level of economic development and maturity of the financial system, which is somehow missing in India’s case, which signals the fact that the rupee can’t be trusted as a medium of exchange.

Going for full capital account convertibility is risky, as it makes a country vulnerable to various kinds of risks. China allowed full capital convertibility only in 2010, and the UK in the 1980s.The two Tarapore committee reports in 1997 and 2006 laid out a path to full convertibility. However, both set up several pre-conditions for the capital account to be fully convertible. For the currency to be an international one, it has to have the capacity to withstand every risk that comes from other countries.

According to the former governor, Rangarjan, for the capital account to be fully convertible, the Indian economy must grow at 7% for the next 25 years, and by 2047, India would be able to allow full convertibility on the capital account. The second challenge is the small size of the Indian economy, which is 3% of the world economy.

When you have such a small share in the global GDP and trade, you naturally have a trade deficit, and there is no advantage for a bilateral trade partner to trade in rupees. Foreign companies will not accept payment in INR when it is at its all-time low against the dollar. For a currency to be an international one, in Rangarajan’s opinion, its fiscal deficit has to be around 3.5% of GDP, gross NPAs around 5%, and CRR 3%, along with a per capita income of $13000. As a matter of fact, its share of global exports was only 2.4% in 2022. The third challenge to it is the concern about the limited liquidity of the Indian rupee.

It is not a widely traded currency, with limited liquidity in the market, making it difficult for investors to buy and sell rupee-denominated assets. The majority of the Indian trade is done in US dollars and euros. According to the recent triennial central bank survey, the dollar accounts for 88% of global forex, which, if taken to India’s case, is only 2%, which reveals the reality check for everyone who has been debating about the internationalization of the Indian rupee. The net investment position of India is negative. The Indian rupee is held by six out of 130 countries, and the big four – dollar, euro, yen, and pound sterling are held by more than 100 out of 130 countries. The fourth challenge is the concern of the underdeveloped financial markets, which provide only limited services for international investors. The total local currency trade volume has been negligible since the project was started.

Russia was unwilling to accept the rupee due to exchange rate volatility and asked it to pay in yuan or dirham. Its imports to India are much higher, making the gap too wide, which makes it unfavourable for Russia to do invoicing in INR. Since India is still a developing economy, there has been an overt role played by the state in the form of acting as a catalyst for the grooming of the private sector.

One of the conditions for any currency to become international is that the embargo of regulations has to be set free in order for the private sector to move in and out of the country easily, which again is missing in India’s case. Arvind Panagariya, professor of economics at Columbia University, says that for the rupee to become an international currency, India must further open its economy and substantially increase its trade.

He draws a parallel with the Chinese yuan’s inclusion in the SDR basket, suggesting that India could aspire to a similar status in the future. At the same time, when the country is going to make the rupee an international currency, there are other competing countries that pose a huge challenge for the rupee to go global. One such country is the Chinese Yuan. The yuan has the 5th biggest share as a global payment currency at 2.5%. In terms of the global turnover of forex, it has a 7% share versus the Indian rupee’s share of 1.6%.

Drawing an inference from the above discussion, it is unlikely for the Indian rupee to go global soon. However, it is likely that it will go global, which will take time and calls for various steps to be taken by the government to strengthen the economy and work at large on the infrastructure of the country, such as social, political, economic, etc. It will happen through an amalgamation of various steps that have to be taken, such as giving people more and more political and economic opportunities.

by: Azher Ahmad Dar, student of Political Science and Economics at the

University of Delhi