Date : 07/07/2023

Reference – GS Paper 3 – Indian Economy – Currency

Keywords – Devaluation, Gulf Rupee, Demonetisation, Current Account Convertibility

Context:

The government's announcement of a long-term roadmap for further internationalisation of the rupee holds potential. In the 1950s, the Indian rupee was widely used as legal tender in the Gulf region, but subsequent events, such as the introduction of the Gulf Rupee and devaluation, led to the decline of its dominance. The demonetisation of 2016 further impacted confidence in the rupee, particularly in neighboring countries like Bhutan and Nepal. To successfully internationalise the rupee, it is essential to address the concerns of these neighboring nations.

Limited International Demand:

The rupee's share in the global foreign exchange market stands at approximately 1.6%, while India's share of global goods trade is around 2%. Although some measures have been taken to promote rupee internationalisation, such as enabling external commercial borrowings in rupees and encouraging rupee-based transactions with select countries, the demand for trading in the Indian rupee remains low. Ongoing negotiations with Russia to settle trade in rupees have been slow, largely due to concerns about currency depreciation and limited awareness among traders about local currency facilities.

Capital Account Convertibility:

To be considered a reserve currency, the rupee must be fully convertible, readily usable, and available in sufficient quantities. However, India currently imposes significant constraints on the exchange of its currency due to past fears of capital flight and exchange rate volatility resulting from current and capital account deficits. Achieving full capital account convertibility is crucial for the internationalisation of the rupee.

Learning from China's Experience:

China's approach to internationalise the Renminbi (RMB) provides valuable lessons. China gradually allowed the use of RMB for various transactions, including trade finance and select investments. Currency swap agreements were signed with several countries, and the establishment of offshore markets facilitated RMB transactions. Over time, the RMB gained international recognition and reserve currency status.

Reforms for Rupee Internationalisation:

To promote the internationalisation of the rupee, several reforms can be pursued:

1. Aim for full convertibility by 2060, allowing free movement of financial investments between India and abroad.
2. Develop a deeper and more liquid rupee bond market to attract foreign investors and provide investment options in rupees.
3. Encourage Indian exporters and importers to invoice transactions in rupees to optimize trade settlement formalities.
4. Establish additional currency swap agreements, like the one with Sri Lanka, to settle trade and investment transactions in rupees.
5. Offer tax incentives to foreign businesses to encourage the use of rupees in operations within India.
6. Ensure currency management stability and improve the exchange rate regime to instill confidence.
7. Seek to make the rupee an official currency in international organizations to enhance its acceptability and profile.
8. Implement recommendations from the Tarapore Committees, including reducing fiscal deficits, inflation rates, and non-performing assets in the banking sector.

Conclusion:

The government's road map for the internationalisation of the rupee aims to benefit Indian businesses, enhance liquidity, and improve financial stability. It should also consider the interests of Indian citizens, enterprises, and the government's ability to finance deficits. Striking a balance between rupee convertibility and exchange rate stability is essential. Implementing predictable currency management policies will be crucial in achieving successful internationalisation of the rupee.

Source – The Hindu