Internationalisation of the Indian Rupee

In News 

• RBI Deputy Governor emphasizes the need for better rupee volatility management to deal with risks of internationalization.

About

• The Reserve Bank of India is making efforts to reduce the use of the US dollar to stabilize the Indian rupee.
• One of the initiatives is allowing invoicing of international trade in Indian rupees instead of dollars and other major currencies.
• The RBI has also set up India’s rupee trade settlement mechanism to attract interest from more countries besides allowing Indian traders to use special Vostro accounts for settling their rupee-denominated trade invoices.
• The first country to open a special Rupee Vostro account is Russia followed by Sri Lanka and Mauritius which are expected to use the Indian rupee trade settlement mechanism.
• As the economy grows and becomes more developed, the scope of participation in foreign exchange markets would change.
• More entities are likely to get exposed to foreign exchange risks with increasing integration with the rest of the world.

What is Internationalisation of Indian Rupee?

• It refers to the process of making the Indian rupee a globally accepted currency, similar to other major currencies like the US dollar, Euro, and Japanese yen etc.,
• This process aims to promote India’s economic growth and development by increasing the use of the rupee in cross-border transactions, foreign investment, and global trade.
• It requires the liberalization of India’s capital account, which means allowing free flow of capital in and out of the country without any restrictions.

Advantages of Internationalization of rupee

• Increased global acceptance: Internationalization of the rupee can increase its global acceptance, which can lead to more international transactions being conducted in the rupee, thereby reducing the demand for foreign currencies and reducing exchange rate risks.
• Reduced transaction costs: Internationalization of the rupee can reduce transaction costs for Indian businesses as they will not have to incur exchange rate fees for converting rupees into foreign currencies for international transactions.
• Boost to trade and investment: Internationalization of the rupee can promote trade and investment by making it easier for foreign businesses to invest in India and for Indian businesses to invest abroad.
• Enhanced competitiveness: A more freely traded rupee can enhance India’s competitiveness in global markets by allowing the currency to reflect the country’s economic fundamentals and reducing the need for the Reserve Bank of India to intervene in currency markets.
• Diversification of reserves: Internationalization of the rupee can diversify India’s foreign exchange reserves away from a concentration in US dollars, reducing the risks associated with holding a single currency.

Challenges of Internationalisation of rupee:

• Exchange rate volatility: It is the primary challenge of internationalising the rupee as it can create risks for businesses and investors that operate in multiple currencies, leading to uncertainty and higher transaction costs.
• Integration with global financial markets: It requires integration with global financial markets, which can pose challenges in terms of regulatory compliance, market infrastructure, and investor protection.
• Limited liquidity: The rupee is not yet a widely traded currency, which means there is limited liquidity in global markets making it difficult for investors to buy and sell rupee-denominated assets, which can limit the attractiveness of the currency.
• Underdeveloped financial markets: India’s financial markets are still relatively underdeveloped compared to other major economies, which can limit the range of products and services available to international investors.
• Regulatory challenges: It requires a supportive regulatory environment that balances the need for openness with the need for financial stability and regulatory oversigh which is challenging to achieve, especially given the complexities of global financial markets.

Steps taken to promote the internationalisation of the Indian rupee

• Liberalisation of capital account: The RBI has progressively relaxed restrictions on capital flows to and from India, thereby facilitating greater cross-border investment and trade.
• Promotion of offshore rupee markets: The RBI has allowed Indian banks to participate in the offshore non-deliverable market for rupee derivatives, which has facilitated the development of offshore rupee markets.
• Currency swap agreements: The RBI has signed currency swap agreements with several countries, which allow for the exchange of rupee and foreign currency between the central banks of the two countries.
• Promotion of rupee-denominated bonds: The government has allowed Indian companies to issue rupee-denominated bonds in international markets, which has helped to increase the demand for the rupee.
• Bilateral trade agreements: The government has signed several bilateral trade agreements with other countries, which has facilitated greater cross-border trade and investment and increased the use of the rupee in international transactions.

Way ahead

• There is need for careful planning and coordination between policymakers, market participants, and regulators to ensure a smooth and successful transition towards the internationalisation of the Indian rupee.
• Overall, increase in the international use of the Indian rupee will go a long way in positioning India as a more attractive destination for foreign investment and trade.

 Source: TH