India has recently initiated the first-ever payment in rupees for crude oil purchased from the United Arab Emirates (UAE), marking a significant step towards the internationalization of the Indian currency. In July 2023, an agreement with the UAE allowed Indian Oil Corporation’s (IOC) rupee payment for a million barrels of crude from ADNOC (Abu Dhabi National Oil Company). Similarly, several Russian oil imports were settled in rupees.
Understanding the Internationalization of the Rupee
The process of internationalization involves promoting the use of the local currency in cross-border transactions. Starting with import and export trade, it extends to other current account transactions and eventually to capital account transactions. Not too long ago, in the 1950s, the Indian Rupee was the legal tender in countries like the United Arab Emirates, Kuwait, Bahrain, Oman, and Qatar. The devaluation of India’s currency by 1966 compelled these nations to introduce their sovereign currencies and decrease dependence on the Indian Rupee.
Benefits of Internationalizing the Indian Rupee
Several advantages accrue with the internationalization of the Rupee. It could lead to the appreciation of the currency’s value by improving demand for the rupee in international trade. This would reduce transaction costs and increase convenience for businesses and individuals dealing with India. When a currency is internationalized, its exchange rate tends to stabilize, offering predictability and reliability for international transactions. Additionally, it could enhance India’s geopolitical influence, strengthen economic ties with other nations, and boost diplomatic relations. Lastly, diversifying settlement currencies can protect India’s economy against global currency shocks.
Challenges in the Internationalization of the Indian Rupee
Notwithstanding its benefits, the process poses several challenges as well. The Triffin Dilemma could arise as a conflict between maintaining domestic economic stability and meeting global demand for the Rupee, putting the economic stability of the country at risk. The currency may also encounter increased exchange rate volatility when exposed to international markets. Moreover, if the Rupee’s internationalization strengthens the currency against others, it might impact import costs, potentially affecting trade balances. The INR is not fully convertible, limiting its widespread use in international trade and finance, and the demonetization exercise in 2016 has affected confidence in the rupee, especially in neighbouring countries like Bhutan and Nepal.
Steps Towards Internationalization
Several initiatives have been undertaken to pave the way for the internationalization of the Rupee. Developments have been made in the GIFT City Asian Clearing Union (ACU) that facilitates the settlement of trade transactions among its member countries. In March 2023, the Reserve Bank of India (RBI) put a mechanism in place for rupee trade settlement with as many as 18 countries, allowing banks from these countries to open Special Vostro Rupee Accounts (SVRAs) for settling payments in Indian Rupees.
Reforms to Aid Internationalization of the Rupee
Various reforms can be pursued to internationalise the Rupee. Among these is making the Rupee more freely convertible and encouraging exporters/importers for transactions in Rupee. A deeper bond market should be pursued to enable foreign investors and Indian trade partners to have more investment options in rupees. Additional currency swap agreements could also be signed to allow India to settle trade and investment transactions in rupees without resorting to a reserve currency such as the US dollar.
Reforms Suggested by the Tarapore Committee
The committee suggested strong fiscal management, including reducing fiscal deficits and inflation rates and cutting down gross banking non-performing assets. It also recommended liberalising the scheme for personal remittance, removing restrictive clauses for Employee Stock Options, and reorienting the department responsible for implementing the Foreign Exchange Management Act, 1999. Lastly, it advised against sudden or drastic changes such as devaluation or demonetisation that can impact confidence, and called for consistent issuance/retrieval of notes and coins.
In essence, the Tarapore Committee’s recommendations should be followed as the primary steps towards the internationalization of the Rupee, accompanied by advocating for the Rupee to become an official currency in international organizations, thus raising its profile and acceptance.
