Internationalisation of the Rupee

10 Jul Internationalisation of the Rupee

This article covers “Daily Current Affairs” and the topic details “Internationalisation of the Rupee”. The topic “Internationalisation of the Rupee” has relevance in the “Indian Economy” section of the UPSC CSE exam.

For Prelims:

What is internationalisation of a currency? What are its benefits and issues? 

For Mains:

GS3: Internationalisation of Rupee and its roadmap 

Why in the news?

Recently, RBI’s Inter-Departmental Group (IDG) said that the Rupee has the potential to become an internationalised currency. 

What does internationalisation of the rupee mean?

Internationalisation of the rupee refers to the process of expanding the usage of the Indian rupee in cross-border transactions. 

The aim is to encourage the utilisation of the rupee in various transactions, including import and export trade, as well as other current account activities, involving residents of India and non-residents. Ultimately, the objective is to extend the use of the rupee to capital account transactions too.

Prerequisites to become an international currency

To become an international currency, certain prerequisites must be met. These include– 

• Further opening up currency settlement, 

• Establishing a robust swap and forex market, 

• Achieving full convertibility of the currency on the capital account. 

• The transfer of funds across borders should be unrestricted.

Historical Context

• Legal Tender in Gulf: In the 1950s, the Indian rupee was widely accepted as legal tender in countries like the United Arab Emirates (UAE), Kuwait, Bahrain, Oman, and Qatar. These Gulf monarchies acquired rupees by exchanging them with the British pound sterling.
• Creation of Gulf Rupee: To address issues related to gold smuggling, the Reserve Bank of India (Amendment) Act was passed in 1959, which led to the creation of the “Gulf Rupee.” This new currency was issued by the central bank specifically for circulation in the West Asian region. People holding Indian currency were given six weeks to exchange it, and the transition occurred smoothly. 
• Decline of Gulf Rupee: However, in 1966, India devalued its currency, resulting in some West Asian countries replacing the Gulf rupee with their own currencies. A decline in confidence regarding the stability of the Indian rupee, coupled with an oil-driven economic boom, gradually led to the introduction of independent currencies in the region. 
• Demonetization: Furthermore, the demonetization policy implemented in 2016 also affected trust in the Indian rupee, particularly in Bhutan and Nepal. These countries remain concerned about potential future policy changes by the Reserve Bank of India, including the possibility of further demonetization.
  • The recent decision to withdraw the ₹2,000 note in 2023 has also affected confidence in the rupee.

Current Status

• Currently, India has achieved full convertibility only on the current account, which covers day-to-day transactions. 

• In the global financial landscape, the leading reserve currencies are the US dollar, the euro, the Japanese yen, and the pound sterling. 
• China has made some efforts to internationalise its currency, the renminbi, but has encountered limited success thus far.

Advantages of Internationalisation of the Rupee

• Mitigates currency risk for Indian businesses:

• • The use of the rupee in cross-border transactions helps Indian businesses to mitigate currency risk.
  • This reduction in currency volatility not only lowers the cost of doing business but also enables better growth opportunities for Indian companies.
  • It improves the chances for Indian businesses to expand globally with more confidence.

• Reduces dependence on foreign exchange reserves:

• • Internationalisation of the rupee decreases the need for holding large foreign exchange reserves.
  • By reducing dependence on foreign currency, India becomes less vulnerable to external shocks.
  • This reduction in dependence on reserves also helps in managing exchange rate volatility and projecting external stability, without imposing a significant cost on the economy.

• Improves bargaining power and global stature:

• • As the use of the rupee becomes more significant in international transactions, the bargaining power of Indian businesses would improve.
  • This increased bargaining power adds weight to the Indian economy in negotiations and business interactions.
  • Consequently, it enhances India’s global stature and respect, elevating its position in the global economic landscape.

Some Disadvantages of Internationalising the Rupee: 

• Increased exchange rate volatility: 
  • If the rupee becomes more widely traded, it will be more susceptible to fluctuations in global financial markets. This could make it more difficult for businesses and investors to plan their financial activities, and could lead to higher transaction costs.

• Reduced monetary policy autonomy: 

• • The Reserve Bank of India (RBI) would have less control over the value of the rupee if it were more widely traded. 
  • This could make it more difficult for the RBI to manage inflation and other macroeconomic variables.

• Increased risk of capital flight: 

• • If the rupee becomes more widely held by foreign investors, there is a greater risk that they could suddenly sell their holdings and withdraw their capital from India. 
  • This could lead to a depreciation of the rupee and a financial crisis.

• Increased vulnerability to external shocks: 

• • If the rupee becomes more integrated with global financial markets, it will be more vulnerable to external shocks, such as changes in interest rates or commodity prices. 
  • This could lead to economic instability in India.

The Recommendations of RBI Working Group

The working group, led by RBI Executive Director Radha Shyam Ratho, has put forward several recommendations to expedite the internationalisation of the rupee. These recommendations span across short, medium, and long-term measures. 

Short-term measures:

• Adoption of a standardized approach for assessing proposals on bilateral and multilateral trade arrangements involving invoicing, settlement, and payment in rupees and local currencies.
• Encouragement of the opening of rupee accounts for non-residents, both within and outside India.
• Integration of Indian payment systems with those of other countries to facilitate smooth cross-border transactions.
• Strengthening the financial market by establishing a global 24×5 rupee market.
• Recalibration of the foreign portfolio investor (FPI) regime to enhance its effectiveness.

Medium-term measures:

• Review of taxes on masala bonds (rupee-denominated bonds issued by Indian entities outside India).
• Promotion of the international use of Real-Time Gross Settlement (RTGS) for cross-border trade transactions.
• The addition of Indian government bonds to global bond indices.

Long-term measures:

• Advocating for the inclusion of the rupee in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR).
• The SDR is an international reserve asset created by the IMF and is based on a basket of five major currencies, including the U.S. dollar, euro, Chinese renminbi, Japanese yen, and British pound sterling.

Conclusion

As stated by MP Varun Gandhi, the government’s plan to internationalize the rupee will facilitate Indian businesses in conducting investments and operations overseas. This initiative aims to increase the liquidity of the rupee and improve financial stability. 

Additionally, it should bring benefits to Indian citizens, enterprises, and the government’s capacity to fund deficits. However, there is a careful trade-off between ensuring rupee convertibility and maintaining exchange rate stability. It is expected that consistent and predictable currency management policies will be implemented to achieve these goals.

Sources:
Internationalisation of rupee: Why and what are the benefits? The Indian Express

Internationalising the rupee without the ‘coin tossing’ – The Hindu 

plutus ias current affairs eng med 10th July 2023

Q1. With reference to ‘Internationalisation of Rupee’ seen in news reports , consider the following statements: 

1. India has achieved full convertibility on both the current and capital account. 
2. One of the major advantages of internationalising the rupee will be reduced vulnerability to external shocks.
3. Internationalisation of the Rupee would help in reducing the dependence on foreign exchange reserves. 

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 2 only

(c) 3 only 

(d) 1, 2 and 3 

Answer: (c) 

Q2. Consider the following currencies: 

1. Renminbi
2. Pound Sterling
3. Swiss Franc
4. South African Rand 
5. Japanese Yen

How many of the currencies stated above are included in the Special Drawing Rights of the IMF?

(a) Only two

(b) Only three

(c) Only four

(d) All five

Answer: (b)

Q3. Discuss the significance and challenges of the internationalisation of the Indian rupee in promoting economic growth and stability.

Gaurav N