GS Paper 3
Syllabus: Economy
Source: IE
Context: According to the RBI, with India remaining one of the fastest-growing countries and showing remarkable resilience in the face of major headwinds, the rupee has the potential to become an internationalised currency.
What does internationalisation of the rupee mean?
- Internationalisation is a process that involves increasing the use of the rupee in cross-border transactions – between residents in India and non-residents.
- It involves promoting the rupee for import and export trade and then other current account transactions, followed by its use in capital account transactions.
- 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.
Prerequisites: The internationalisation of the currency, which 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 (allowing free movement of local financial investment assets into foreign assets and vice-versa) and
- Cross-border transfer of funds without any restrictions.
Current scenario:
- India has allowed only full convertibility on the current account as of now.
- The US dollar is said to enjoy an ‘Exorbitant Privilege’, supported by a range of factors, including the size of the US economy, a history of macroeconomic stability and currency convertibility, lack of viable alternatives, etc.
- Chinese Renminbi is the obvious challenger to the US dollar dominance. However, its ability to rival the US dollar will depend on the –
- Chinese economy and its financial system to demonstrate the same long-term resilience,
- Integrity, transparency, openness and stability, which are characteristics of the US economy.
The RBI recommendations:
| Short term | Long term |
| Adoption of a standardised approach for examining the proposals on bilateral and multilateral trade arrangements | The inclusion of the rupee in IMF’s SDR (special drawing rights)
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. |
| Encouraging the opening of the rupee accounts for non-residents both in India and outside India | |
| 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 and inclusion of Indian Government Bonds in global bond indices |
These recommendations are significant:
- In light of the economic sanctions imposed by the US on Russia for invading Ukraine and the growing clamour for finding an alternative to the US dollar for international transactions.
- While reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy.
Advantages of internationalisation of the rupee:
- Cross-border transactions mitigate currency risk for Indian businesses by protecting them from currency volatility. This will –
- Reduce the cost of doing business and improve the chances for Indian businesses to grow globally.
- Add weight to the Indian economy and enhance India’s global stature and respect.
- Internationalisation of the rupee reduces the need for holding foreign exchange reserves.
- Reducing dependence on foreign currency will make India less vulnerable to external shocks.
Challenges:
- Very little international demand: The daily average share for the rupee in the global foreign exchange market is ~1.6%, while India’s share of global goods trade is ~2%.
- India does not permit full capital account convertibility: It is driven by 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.
Reforms needed:
- Rupee must be made more freely convertible, with a goal of full convertibility by 2060.
- The RBI should pursue a deeper and more liquid rupee bond market, enabling foreign investors and Indian trade partners to have more investment options in rupees.
- Indian exporters and importers should be encouraged to invoice their transactions in rupee.
- Currency swap agreements (as with Sri Lanka) would further allow India to settle trade and investment transactions.
- Tax incentives to foreign businesses to utilise the rupee in operations in India would also help.
- The Tarapore Committees’ (in 1997 and 2006) recommendations must be pursued including –
- A push to reduce fiscal deficits lower than 3.5%,
- A reduction in gross inflation rate to 3%-5%, and
- A reduction in gross banking non-performing assets to less than 5%.
Insta Links:
Mains Links:
It is essential to approach the internationalisation of the rupee cautiously, considering the potential advantages and risks associated with it. Critically examine.
