Internationalisation of rupee: Why and what are the benefits?

What’s in today’s article?

• Why in News?
• The Internationalisation of the Rupee
• Why does the US dollar enjoy an ‘Exorbitant Privilege’ and its obvious Challenger?
• The RBI’s Recommendations
• Advantages of Internationalisation of the Rupee
• Way Ahead

 

Why in News?

• According to the Reserve Bank of India’s (RBI) inter-departmental group (IDG), the rupee has the potential to become an internationalised currency.
• These recommendations are significant, with India remaining one of the fastest-growing countries and showing remarkable resilience in the face of major headwinds.

 

The Internationalisation of the Rupee:

• Meaning:
  • Internationalisation is a process that involves increasing the use of the rupee in cross-border transactions. These are all transactions between residents in India and non-residents.
  • It involves -
    • Promoting the rupee for import and export trade and then other current account transactions (measures imports and exports of goods and services, etc),
    • Followed by its use in capital account transactions - measures cross-border investments in financial instruments, etc.
• It is closely interlinked with:
  • The nation’s economic progress,
  • Further opening up of the currency settlement and a strong swap and forex market,
  • Full convertibility of the currency on the capital account and
  • Cross-border transfer of funds without any restrictions.
• Currently,
  • The US dollar, 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 has met with only limited success so far.
  • India has allowed only full convertibility on the current account as of now.
• Need for alternatives: In light of the economic sanctions imposed by the US on Russia for invading Ukraine led to the growing clamour for finding an alternative to the US dollar for international transactions.

 

Why does the US dollar enjoy an ‘Exorbitant Privilege’ and its obvious Challenger?

• The dollar’s position is supported by a range of factors, including -
  • The size of the US economy,
  • The reach of its trade and financial networks,
  • The depth and liquidity of US financial markets, and
  • A history of macroeconomic stability and currency convertibility.
  • Dollar dominance has also benefited from the lack of viable alternatives.
• The obvious challenger to the US dollar dominance is the Chinese Renminbi. However, its ability to rival the US dollar will depend on -
  • Future policies in both the US and China and
  • The ability of the Chinese economy and its financial system to demonstrate the same long-term resilience, integrity, transparency, openness and stability.

 

The RBI’s Recommendations:

• For the short term,
  • Adoption of a standardised approach for examining the proposals on bilateral and multilateral trade arrangements.
  • Encouraging the opening of the rupee accounts for non-residents both in India and outside India and integrating Indian payment systems with other countries for cross-border transactions.
  • Strengthening the financial market by fostering a global 24×5 rupee market and recalibration of the FPI (foreign portfolio investor) regime.
  • A review of taxes on masala (rupee-denominated bonds issued outside India by Indian entities) bonds, international use of Real Time Gross Settlement (RTGS) for cross-border trade transactions, etc.
• For the long term,
  • Efforts should be made for the inclusion of the rupee in International Monetary Fund’s (IMF) special drawing rights (SDR).
  • The SDR is an international reserve asset created by the IMF to supplement the official reserves of its member countries.
  • The value of the SDR is based on a basket of five currencies [the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling].

 

Advantages of Internationalisation of the Rupee:

• Mitigates currency risk for Indian businesses: The use of the rupee in cross-border transactions will protect Indian businesses from currency volatility.
  • This will reduce the cost of doing business, enable better growth of business and improve the chances for Indian businesses to grow globally - helping to raise the stature of India and its economy globally.
• Reduces the need for holding foreign exchange reserves: While reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy.
• Reducing dependence on foreign currency: It will make India less vulnerable to external shocks.

 

Way Ahead:

• India’s past fears of capital flight (outflow of capital from India due to monetary policies/lack of growth) and exchange rate volatility (given significant current and capital account deficits), does not permit full capital account convertibility.
• Therefore, the Tarapore Committees’ recommendations of 1997 and 2006 (reducing fiscal deficits to below 3.5%, gross inflation rate to 3%-5% and gross banking NPAs to below 5%) must be pursued before full capital account convertibility.

 

---

Q1) What do you mean by full convertibility of rupee?

Full convertibility of rupee means the right of a resident to convert rupee into foreign currency and vice versa for all purposes - both current account transactions and capital account transactions.

 

Q2) What are currency swap agreements?

Currency swaps are financial contracts between two parties to exchange a specific amount of one currency for an equivalent amount of another currency. The purpose of currency swaps is to reduce currency risk, achieve lower financing costs, or gain access to a foreign currency.

 

---

Source: Internationalisation of rupee: Why and what are the benefits?