Internationalisation of rupee

Internationalisation of rupee

Subject: Economy

Section: External Sector

Context: The Reserve Bank of India’s (RBI) inter-departmental group (IDG) has recommended a roadmap to achieve the internationalisation of the rupee.

Key Points:

What is Internationalisation?

• Internationalisation is a process that involves increasing the use of the rupee in cross-border transactions, similar to the other reserve currencies such as the US dollar, the Euro, the Japanese yen and the pound sterling.
• It involves promoting the rupee for current account transactions including import and export trade, and eventually capital account transactions.
• It requires further opening up of the currency settlement and a strong swap and forex market.
• Full convertibility of the currency on the capital account is also needed along with cross-border transfer of funds without any restrictions. (India has allowed only full convertibility on the current account as of now.)

Why do it?

• India remains 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.
• Impact of Sanctions on Russia:
  • Timing of recommendation is significant as it comes at a time when the economic sanctions imposed by the US on Russia for invading Ukraine is resulting in countries looking at an alternative to the US dollar.
  • Countries also want to reduce theri dependence on dominant international payment mechanisms based on the Society for Worldwide Interbank Financial Telecommunications (SWIFT) messaging system.
  • Countries are realising that having a strong foreign exchange reserves to manage external shocks, is no longer a sufficient defence against the threat of economic sanctions.

Advantages of internationalisation of the rupee:

• Reduced currency risk: The use of the rupee in cross-border transactions mitigates currency risk for Indian businesses.
• Reduced volatility: With wider adoption of a currency its value is more stable. Protection from currency volatility not only reduces the cost of doing business, it also enables better growth of business, improving the chances for Indian businesses to grow globally.
• Freedom from reserve: 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.
• Bargaining power: As Rupee’s acceptance in the world grows the bargaining power of Indian businesses would improve, as they can price goods in Rupee and not worry about currency fluctuations.

Concerns:

• Short term volatility: Internationalisation may initially result in increased volatility in the exchange rate of INR.
• Monetary policy difficulties: There will be monetary implications as the global obligations towards supplying currency to meet the global demand may conflict with its domestic monetary policies objectives. (This is known as the Triffin dilemma)
• External Shock: Internationalisation of a currency may magnify external shocks, given the open channel of the flow of funds into and out of the country and from one currency to another.
• Financing: International currency use can have an undesirable impact on financing conditions, especially when a country is a net receiver of capital flows in the form of FDI and FPI.
• Cost of additional demand: Costs of meeting the additional demand for money along with the increase in the volatility of the demand pose other challenges.