Internationalisation of the Rupee refers to the process of increasing the use of India’s local currency, the rupee, in cross-border transactions. This involves promoting the rupee for import and export trade and other current account transactions, followed by its use in capital account transactions. Currently, the rupee is fully convertible in the current account but partially in the capital account. The two main components of balance of payments are Current and Capital accounts.
The Current Account primarily deals with the import and export of goods and services. In contrast, the Capital Account comprises the cross-border movement of capital through investments and loans.
The Need for the Internationalisation of Rupee
In the global foreign exchange market turnover, the dollar occupies 88.3%, followed by the euro, Japanese Yen, Pound Sterling, while the rupee features at a mere 1.7%. This underlines the need for pushing the rupee much farther to attain an international tag. An international currency like the dollar enjoys certain ‘exorbitant’ privileges, including immunity from Balance of Payments crises since the USA can pay for its external deficits using its own currency.
The Advantages of Internationalising the Rupee
Using the rupee in cross-border transactions guards Indian businesses against currency risk and protects them from the volatility of foreign currencies. This not only reduces the cost of doing business but also enhances the potential growth of businesses, making them more globally competitive. It also diminishes the necessity for holding foreign exchange reserves. Although these reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy. Reducing reliance on foreign currency safeguards India against external shocks.
The Challenges in the Internationalisation of Rupee
India, as a capital deficit country, requires foreign capital to fund its growth. If a substantial portion of its trade is carried out in Rupee, non-residents would hold rupee balances in India, used to acquire Indian assets. Large holdings of such financial assets could increase vulnerability to external shocks. A reduction in the role of convertible currencies in external transactions could lead to reduced reserve accretion.
Steps Taken for the Internationalisation of the Rupee
In July 2022, the Reserve Bank of India introduced a mechanism to facilitate international trade in rupees. It enabled external commercial borrowings in Rupees, notably Masala Bonds. Efforts are also underway, through the Asian Clearing Union, to explore using domestic currencies for settlement.
The Way Forward
The recent initiative to invoice trade in rupee comes from a unique global requirement and order. However, for true internationalisation and wider use of the rupee overseas, opening up trade settlement in rupee alone will not suffice. Further opening up and liberalised settlements in rupee for various financial instruments both in India and overseas markets are more critical.
Rupee internationalization may additionally require an efficient swap market and a strong foreign exchange market. Furthermore, improvement in overall economic fundamentals, financial sector health, followed by an upward movement in sovereign ratings, will bolster confidence in the rupee, preparing the currency for the next step in its international journey.
