Internationalization of Rupee

Table of Contents

Context: An Inter-Departmental Group (IDG), headed by RBI has recommended various measures to accelerate the pace of internationalisation of the rupee.

What is International Currency?

The Tarapore Committee on Fuller Capital Account Convertibility (CFAC) defined international currency as ‘a currency that is widely used for international transactions.
An international currency is supposed to perform three international functions (see image).

For example, today, the US dollar is the most widely accepted currency for international transactions, followed by Euro.
In the early 1960s, even rupee was accepted as legal tender in Qatar, UAE, Kuwait, Bahrain, Oman and Malaysia. But, today, almost 86% of India’s imports as well as 86% of the exports are invoiced in dollars.

What is Internationalization of Rupee?

Internationalization of a currency (rupee here) is a process to increase rupee acceptance (credibility) across the world through activities such as:
- Increased use for invoicing and settlement of cross-border transactions
- Freedom for non-residents to hold financial assets/liabilities in rupee
- Freedom for non-residents to tradable balances in rupee at offshore locations.
It can also be referred to adopting full capital account convertibility, i.e., freedom to convert local financial assets into foreign financial assets and vice versa.
- Currently, India allows partial Capital Account Convertibility and full current account convertibility.
The IDG said that the rupee has the potential to become an internationalized currency as India is one of the fastest growing countries and has shown remarkable resilience even in the face of major global headwinds.
It said that higher usage of the rupee in invoicing and settlement of international trade, as well as in capital account transactions, will give the domestic current a progressively international presence.

Benefits of Internationalization of Rupee

Reduced Exchange Rate Volatility: Increased international usage of a currency can potentially reduce the exchange rate volatility by increasing demand for the currency, which can make it more stable and predictable.
- Exchange rate volatility is defined as the risk associated with unexpected movements in the exchange rate.
Reduced Vulnerability to External Shocks: because of reduced dependence on foreign currency.
Enhanced International Trade: Internationalization of the rupee can lead to greater acceptance of the currency, which would make international trade easier and more efficient for Indian businesses.
Improved current account deficit: The use of the rupee for international transactions could potentially reduce trade costs and make it easier for Indian businesses to conduct transactions with foreign partners.
- This, in turn, could lead to an increase in exports and a reduction in imports, which could help to improve the current account balance.
Enhance India’s global stature and respect: It will help Indian Businesses through increased bargaining power. E.g., Post-2008 recession, Chinese efforts to internationalize Renminbi helped in increasing its global stature.

Challenges in Internationalization of Rupee

Complicates Domestic Monetary Policy: The internationalization of the rupee could limit the effectiveness and independence of the RBI in controlling domestic money supply.
Increased Refinancing Risk: It could aggravate the pass-through risks of external stimulus to domestic financial markets from non-resident holdings of the rupee.
- During a global recession, for example, non-residents could convert their rupee holdings and move out, increasing refinancing risk.
Heightened Exchange Rate Volatility: The value of the rupee could become more volatile, particularly if the inflation rate is higher than the global rate or from uncontrolled flow of capital.
Increased Responsibility to Maintain International Financial and Monetary System Order: This puts an increased burden to play the role of “Lender of Last Resort” in case of any global financial crisis.

Recommendations by the Inter-Departmental Group (IDG)

Short-term measures	A standardised approach or /uniform template should be adopted for bilateral and multilateral trade agreements, local currency settlement mechanisms and bilateral swaps. Use of the existing bilateral and multilateral payment and settlement mechanisms, such as ACU (Asian Clearing Union), to internationalize the rupee. Non-residents should be allowed to open rupee account as the ability to open accounts outside the country of the currency is a foundational element of the internationalisation of a currency. RBI should step up measures for the inclusion of Indian Government Bonds (IGBs) in global bond indices. Rationalisation of the FPI regime to facilitate a more conducive environment for foreign investments into the Indian debt markets (both government and corporate).
Medium-term measures	Review of withholding tax for masala bonds issuances. Masala Bonds are rupee-denominated bonds issued outside India by Indian entities. They are debt instruments which help to raise money in local currency from foreign investors. Expansion of RTGS (Real Time Gross Settlement) system for settling international transactions and inclusion of the rupee in Continuous Linked Settlement (CLS) system. Continuous Linked Settlement (CLS) is a global initiative to reduce foreign exchange settlement risk by settling both legs of foreign exchange transactions simultaneously.
Long-term measures	As part of the long-term measures to achieve internationalisation of the rupee, the group suggested inclusion of the rupee in SDR (Special Drawing Rights) basket. The SDR is an international reserve asset created by the IMF (International Monetary Fund) 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.

Way Forward: Internationalization of Rupee has significant benefits but to achieve it successfully, would require some pre-requisites-

Building a Strong Domestic Financial Market: To successfully withstand external shocks, it is crucial to establish a strong domestic financial market with robust infrastructure, including efficient funding and risk transfer mechanisms.
Increasing Rupee Acceptance as currency for reserves: i.e., currency in which assets are held. E.g., foreign countries held a total of 7.2 trillion U.S. dollars in U.S. treasury securities as of November 2022.
Boosting India’s trade: There is a need to enhance India’s Share in Global Merchandise and Commercial Services Trade, helping the rupee to gain global acceptance.
Handling of capital inflows: Optimal handling of the inflow of capital (volume and composition) using a suitable mix of policies, macro-prudential regulations, and market interventions.