Internationalization of the Indian Rupee
Context:
The government’s recent announcement for the internationalization of the Indian rupee brings historical context, but challenges such as devaluation and demonetization have impacted confidence. Addressing concerns from neighboring countries is crucial for a successful rupee internationalization.
Relevance:
GS-03 (Indian Economy)
Prelims:
- Internationalization of the Indian Rupee
- Monetary Policy
- Foreign trade policy
- RBI
- Foreign reserve
Mains Questions:
1. What are the factors hindering the internationalization of the Indian rupee and how can India learn from China’s experience in internationalizing its currency, the Renminbi? (150 words)
Dimensions of the Article:
- Limited International Demand
- Capital Account Convertibility and Exchange Rate Volatility
- Learning from China’s Experience
Limited International Demand:
- The Indian rupee still lacks international recognition, with its daily average share in the global foreign exchange market standing at approximately 1.6%, despite India accounting for around 2% of global goods trade.
- Although some efforts have been made to promote the internationalization of the rupee, such as enabling external commercial borrowings and facilitating trade in rupees with certain countries, these initiatives have yielded limited results.
- The dominance of the US dollar in global oil trade and the lack of awareness among traders about local currency facilities have further hindered the demand for trading in the Indian rupee.
Capital Account Convertibility and Exchange Rate Volatility:
- For the rupee to be considered a reserve currency, it must possess full convertibility, be readily usable, and be available in sufficient quantities. However, India currently imposes significant constraints on capital account convertibility due to past concerns about capital flight and exchange rate volatility.
- These limitations arise from the fear of outflows of capital from India due to monetary policies and lack of economic growth, coupled with substantial current and capital account deficits.
Learning from China’s Experience:
- China’s successful internationalization of the Renminbi provides valuable lessons for India. China adopted a phased approach, gradually allowing the use of the Renminbi outside its borders for various transactions, including current account transactions and select investment transactions.
- Currency swap agreements with multiple countries and the establishment of offshore clearing banks and participating banks played a crucial role in facilitating the Renminbi’s internationalization.
- The creation of a more liquid bond market denominated in the Renminbi and the introduction of the Shanghai Free Trade Zone further bolstered its international use and reserve currency status.
Way Forward:
- Enhancing Convertibility and Liquidity: To internationalize the rupee, India must focus on making it more freely convertible, with the goal of achieving full convertibility by 2060. This entails allowing financial investments to move freely between India and other countries, thereby increasing the rupee’s attractiveness and liquidity. Creating a deeper and more liquid rupee bond market would provide foreign investors and Indian trade partners with more investment options in rupees, fostering its international use.
- Encouraging Invoicing in Rupees: Indian exporters and importers should be encouraged to invoice their transactions in rupees. Streamlining trade settlement formalities for rupee import/export transactions would significantly contribute to the internationalization process. Moreover, entering into additional currency swap agreements with countries, as done with Sri Lanka, would facilitate trade and investment settlements in rupees, reducing reliance on reserve currencies such as the US dollar.
- Currency Management and Stability: Ensuring stability in currency management, including consistent and predictable issuance/retrieval of notes and coins, is vital. The Reserve Bank of India and the Ministry of Finance must improve the exchange rate regime and avoid frequent demonetization or devaluation, as these measures can impact confidence in the rupee. Implementing the recommendations put forth by the Tarapore Committees, such as reducing fiscal deficits, managing inflation, and addressing non-performing assets in the banking sector, will also contribute to overall stability.
Conclusion:
The government’s road map for the internationalization of the rupee holds the potential to benefit Indian businesses, enhance financial stability, and enable the government to finance deficits more effectively. However, achieving a delicate balance between rupee convertibility and exchange rate stability is crucial. By pursuing the necessary reforms outlined above and learning from China’s experience in internationalizing its currency, India can make significant progress in positioning the rupee as a globally recognized and widely accepted currency.
