Putting the Rupee on the Global Map

The original version of the article was published on 24th March 2023 in “The Daily Guardian.

India has witnessed an exponential rise in its share of the global economy in the last couple of decades. India's merchandise exports saw a jump of a staggering $122 billion between 2012-13 and 2021-22 whereas its imports increased by $117 billion in the same period.

The rise in trade has also boosted the country's foreign exchange (forex) reserves from $292 billion in 2012-13 to $607 billion at the end of the 2021-22 financial year. A strong forex reserve has hedged the Indian economy from international shocks. However, reliance on the US Dollar for forex trade, investment, and inflows implies incurring additional expenditure on exchange rates and rising costs of maintaining forex reserves.

In July 2022, the Reserve Bank of India (RBI) introduced a mechanism to facilitate international trade in Indian Rupee. The mechanism facilitates the settlement of import and export payments in Indian currency through a special Vostro account and places the Indian currency firmly on the path to internationalisation.

The Indian Rupee, which saw a decline in value vis-a-vis the US Dollar in the last few months, largely owing to rising oil prices (primarily due to the Russia-Ukraine conflict), strengthened its position in comparison to other major currencies. Moving the Indian Rupee towards internationalisation will not only further integrate the Indian economy into the global economy and strengthen the country's financials but also open up new challenges around regulations, something Indian authorities need to account for well in advance.

International Currency: What does it mean to be one?

An international currency is a currency used to settle cross-border transactions involving any purchase of goods, services, or financial assets instead of the national currencies of the parties involved. An international currency has wide global recognition and is easily convertible into other currencies. While cross-border trade can be in any currency, the wide acceptability of an international currency makes it a popular medium of exchange.

International currencies gain recognition due to varied factors and the status is primarily a reflection of the trust in the currency and the parent economy. The British Pound Sterling gained prominence as a widely accepted currency for international trade during the colonial period. The US Dollar, on the other hand, emerged as the most widely used currency for international trade after an agreement at the Bretton Woods Conference in 1944 to use it as the world's reserve currency.

One of the most commonly accepted international currencies include the US Dollar with a global daily average trading volume of about $6.6 trillion followed by the Euro, the second most traded currency constituting a daily average trading volume of almost $2.3 trillion. The Japanese Yen and the British Pound Sterling rank a distant third and fourth with trading volumes at $1.2 trillion and $968 billion, respectively. Over the course of the last few decades, China's rising dominance as a global player is commensurate with the Chinese government's efforts to promote the Chinese Yuan or Renminbi as a global trading currency. As a result, the currency has emerged as the fifth most traded currency in the world with an average of $526 billion in daily trading volume.

Indian Rupee as An International Medium

The RBI's trade settlement system, set up in July 2022, has been attracting interest from countries across the world. The mechanism facilitates the usage of the Indian Rupee for cross-border financial transactions through a Vostro account, thereby reducing dependence on existing international currencies. The RBI has granted permits to banks from 18 countries to open Special Vostro Rupee Accounts (SVRAs) to settle payments in rupees. These 18 economies range from developed countries to emerging economies such as Botswana, Fiji, Germany, New Zealand, Sri Lanka, and the United Kingdom. Russia, by completely replacing the US Dollar and Euro for international financial settlements, became the first country in the world to begin settlement of foreign trade in the Indian Rupee, a push facilitated by the US sanctions on Russia in light of the Russia-Ukraine conflict.

In recent years, the United States is known to use US Dollar dominance as a means to arm-twist countries into accepting its geopolitical stands. Moreover, a strengthening US Dollar has made it more expensive for many countries to import essential items. This has generated further demand for an alternative currency. Tajikistan, Cuba, Luxembourg, and Sudan are also in talks with India to use the Vostro mechanism. India is having discussions with key oil suppliers Saudi Arabia and the United Arab Emirates (UAE), amongst other large trading partners, to denominate trade in rupees.

The launch of the wholesale and retail Digital Rupee in November-December 2022 as a central bank digital currency (CBDC) will further the usage of the Indian Rupee as a medium of exchange beyond Indian borders. Adding the needed resilience in the way payments are made, the Digital Rupee will boost cross-border payment space by reducing dependency on physical paper currency. Shifting to a digital currency will reduce trade and transactions in cryptocurrencies and address concerns related to money laundering, terror financing, and tax evasion.

The cost-effective and time-efficient nature of CBDC will aid the internationalisation of the Indian Rupee by bolstering the integration of the domestic economy in foreign trade and international capital flows. Over the course of the last few years, the RBI has taken several steps to liberalise the exchange rate mechanism, boosting the rupee's appeal as a reserve currency and pushing it towards becoming a more widely accepted currency for international trade.

Benefits of Internationalizing Indian Rupee

The internationalisation of the Indian Rupee is slated to bring several benefits to the domestic economy. For starters, undertaking economic transactions with the rest of the world in the Indian Rupee will lower the transaction cost of cross-border trade and investment operations by mitigating exchange rate risk and eliminating conversion charges. The use of rupees for international financial transactions, the ultimate form of internationalisation of a currency, will offer wider business opportunities in global capital markets for domestic financial institutions.

Moreover, the expanded scope of internationalisation of the rupee will ease foreign trade and aid capital flow, reduce dependence on forex reserves and bring down maintenance costs of forex reserves. It is slated to help boost the domestic economy by increasing trade volume, both import and export. Internationalisation of the Indian Rupee will also lead to increased trust in the Indian economy thereby making it easier for domestic players to attract both direct and institutional investment.

Is India Prepared?

Using a currency for international trade has to go beyond the currency being a medium of exchange for goods and services trade. It must reflect the ability to support transactions in the capital markets as well. This calls for greater integration and opening up of the domestic economy and the financial sector to international markets. While there are ample benefits a country gets as its currency becomes more widely used for global transactions, it also entails greater exposure to international economic shocks and exchange rate fluctuations. As the Indian Rupee gets more widely used in financial transactions, large holdings of financial assets in the Indian Rupee will heighten vulnerability to external shocks.

As the domestic economy becomes more integrated and exposed to the international economy, regulatory measures introduced within the country will have a greater impact on the global scale and will call for a more cautious application of the domestic monetary policy. It will require the adoption of a nuanced approach to policy formulation and implementation, factoring in the impact on the global economy aside from what happens at home.

The RBI is already putting enabling mechanisms in place to empower domestic banks to operate in offshore markets. This is facilitating better linkages between the domestic Indian Rupee interest rates and currency markets with offshore Indian Rupee markets. Incorporating the rupee trade settlement mechanism in July 2022, the launch of the retail version of the Digital Rupee, strengthening internal policy mechanisms to regulate financial markets, steps to liberalise the exchange rate mechanism, and measures to further integrate the domestic capital markets with international markets will move the Indian Rupee closer to becoming an international currency in the coming years.

Damini Mehta/New Delhi
From Polstrat, a non-partisan political consultancy which aims to shift the narrative of political discourse in the country from a problem-centric to a solutions-oriented approach.