Internationalisation of Indian Rupee

• 08 Jul 2023

For Prelims: Reserve Bank of India, Internationalisation of the rupee, Legal tender, Demonetization, Real-Time Gross Settlement , International Monetary Fund.

For Mains: Benefits of Internationalisation of Rupee, Steps Towards Internationalization of Rupee

Why in News?

A Reserve Bank of India-appointed working group recommended inclusion of the rupee in the Special Drawing Rights (SDR) basket and recalibration of the foreign portfolio investor (FPI) regime to accelerate the pace of internationalisation of the rupee.

What is Internationalisation of Rupees?

• About:
  • Internationalisation of rupees is a process that involves increasing use of the local currency in cross-border transactions.
  • It involves promoting the rupee for import and export trade and then other current account transactions followed by its use in capital account transactions.
• Historical Context:
  • In the 1950s, the Indian rupee was widely used as legal tender in the United Arab Emirates, Kuwait, Bahrain, Oman, and Qatar.
  • However, the devaluation of India’s currency by 1966 led to the introduction of sovereign currencies in these countries to reduce reliance on the Indian rupee.
• Benefits of Internationalisation of Rupee:
  • Appreciate Currency Value: It will improve the demand for the rupee in international trade.
    • This can lead to increased convenience and reduced transaction costs for businesses and individuals dealing with India.
  • Reduced Exchange Rate Volatility: When a currency is internationalized, its exchange rate tends to stabilize.
    • The increased demand for the currency in global markets can help reduce volatility, making it more predictable and reliable for international transactions.
  • Geopolitical Advantages: Internationalizing the Rupee can enhance India's geopolitical influence.
    • It can strengthen economic ties with other countries, facilitate bilateral trade agreements, and promote diplomatic relations.
• Challenges:
  • Limited International Demand:
    • The daily average share for the rupee in the global forex market is only around 1.6%, while India’s share of global goods trade is ~2%.
  • Convertibility Concern:
    • The INR is not fully convertible, meaning there are restrictions on its convertibility for certain purposes such as capital transactions. This restricts its widespread use in international trade and finance.
  • Demonetization Impact:
    • The demonetization exercise in 2016, along with the recent withdrawal of the ₹2,000 note, has affected confidence in the rupee, particularly in neighboring countries like Bhutan and Nepal.
  • Challenges in Trade Settlement:
    • While efforts have been made to trade with around 18 countries in rupees, transactions have remained limited.
    • Also, negotiations with Russia to settle trade in rupees have been slow, hampered by currency depreciation concerns and inadequate awareness among traders.
• Steps Towards Internationalization:
  • In March 2023, the RBI put in place the mechanism for rupee trade settlement with as many as 18 countries.
    • Banks from these countries have been allowed to open Special Vostro Rupee Accounts (SVRAs) for settling payments in Indian Rupees.
  • In July 2022, the RBI issued a circular on “International Trade Settlement in Indian Rupees”.
  • RBI enabled external commercial borrowings in Rupees (especially Masala Bonds)

What can be Done to Pace-up Internationalization of Rupee?

• Full Convertibility and Trade Settlement: The Rupee should aim for full Convertibility, allowing free movement of financial investments between India and other countries.
  • Encouraging Indian exporters and importers to invoice transactions in rupees would optimize trade settlement formalities.
• Liquid Bond Market: RBI should focus on developing a more liquid rupee bond market, providing investment options for foreign investors and trade partners.
  • Also, there is a need to recalibrate the foreign portfolio investor (FPI) regime in order to enhance the speed at which the rupee is internationalized.
• Expansion of RTGS system: The Real-Time Gross Settlement (RTGS) system should be expanded to settle international transactions.
  • Also, providing tax incentives to foreign businesses utilizing the rupee in India would promote its use.
• Currency Swap Agreements: Increasing currency swap agreements, as seen with Sri Lanka, would facilitate trade and investment transactions in rupees.
  • Consistent and predictable currency issuance and retrieval, along with a stable exchange rate regime, are essential for maintaining confidence.
• Inclusion in the SDR basket: Rupee should be pitched to get included in Special Drawing Rights (SDR), which is an international reserve asset created by the International Monetary Fund (IMF) based on a basket of major currencies.
  • Also, Indian Government Bonds (IGBs) can be included in global indices, attracting foreign investments into Indian debt markets.
• Lessons from China's Experience: China's approach to internationalizing the Renminbi provides valuable insights for India:
  • Phased Approach: China gradually enabled the use of the Renminbi for current account transactions and select investment transactions before progressing towards its use as a reserve currency.
  • Offshore Markets: The establishment of offshore markets, such as the Dim Sum bond and offshore RMBD bond market, facilitated the internationalization process.

Note:

• Foreign Portfolio Investment (FPI): It consists of securities and other financial assets passively held by foreign investors.
  • It is part of a country’s capital account and is shown on its BOP.
  • It does not provide the investor with direct ownership of financial assets.
  • FPI is more liquid, volatile and therefore riskier than FDI.
  • It is often referred to as “hot money”.
  • Examples - Stocks, bonds, mutual funds, exchange traded funds.
• Special Drawing Rights:
  • SDR serves as the unit of account of the IMF, but it is neither a currency nor a claim on the IMF.
  • The SDR basket of currencies includes the US dollar, Euro, Japanese yen, pound sterling and the Chinese renminbi (included in 2016).

Conclusion

The Tarapore Committee's recommendations (in 1997 and 2006), including reducing fiscal deficits, inflation rates, and banking non-performing assets, should be pursued as a primary step towards internationalisation of rupee. Also, advocating for the rupee to become an official currency in international organizations would raise its profile and acceptance.

UPSC Civil Services Examination, Previous Year Questions (PYQs)

Prelims:

Q1. Convertibility of rupee implies (2015)

(a) being able to convert rupee notes into gold
(b) allowing the value of rupee to be fixed by market forces
(c) freely permitting the conversion of rupee to other currencies and vice versa
(d) developing an international market for currencies in India

Ans: (c)

Q2. With reference to Balance of Payments, which of the following constitutes/ constitute the Current Account? (2014)

Balance of trade

Foreign assets

Balance of invisibles

Special Drawing Rights

Select the correct answer using the code given below:

a.1 only
b. 2 and 3
c. 1 and 3
d. 1, 2 and 4

Ans: (c)

Source: TH