Internationalization of the rupee indicates that it may be freely exchanged between residents and non-residents and that it can be used as a reserve currency in international trade. It entails encouraging the use of the rupee for capital account transactions, other current account operations, and import and export trade.
International Trade Settlement in Indian Rupees (INR)
To promote the growth of global trade with an emphasis on exports from India and to support the increasing interest of the global trading community in Indian currency (INR), the Reserve Bank of India (RBI) announced a new mechanism for international trade settlement in Indian rupees (INR). To encourage the use of theIndian currency in cross-border trade is one of the major goals of the Foreign Trade Policy (FTP) 2023 of India which comes into effect from April 1, 2023.
The RBI has also updated from time to time about the broad framework for exporting goods and services from India according to the Master Direction of the Foreign Exchange Management Act, 1999 (FEMA). The approved dealer banks will need prior clearance from the RBI's foreign currency department before implementing this method. All exports and imports made in accordance with this arrangement may be priced in rupees.
Market forces may decide the rate of exchange between the currencies of the two trade partners. The authorised dealer banks (DB) have been allowed to open rupee Vostro accounts (an account that a correspondent bank holds on behalf of another bank). The rupee payment system also allows Indian exporters to collect advance payments in Indian rupees from foreign importers against shipments. The surplus rupee balance in the Vostro accounts may be used for advanced flow management of export-import transactions, investments in government securities, and payments for projects and investments.
According to the RBI, the authorised dealer bank maintaining the special Vostro account will have to ensure that the correspondent bank is not from a country or jurisdiction in the updated public statement of the Financial Action Task Force (FATF) on high-risk and non-cooperative jurisdictions on which FATF has called for countermeasures.
Driving factor
In a move to counter Russia’s war over Ukraine, the US and the European Commission issued a joint statement to exclude seven Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) messaging system, which was the trigger point for all countries. This payment arrangement assumed greater importance in 2022–23 as India increased its dependence on discounted Russian oil, making it the second largest source of crude oil. Russia's exports to India in 2021 stood at $6.9 billion, mainly consisting of mineral oils, fertilisers, and rough diamonds, while India exported goods worth $3.33 billion to Russia in 2021, mainly comprising pharmaceutical products, tea, and coffee.
In December 2022, India did its first settlement of foreign trade in rupees with Russia as part of the 'International Settlement of Trade in Indian Rupee' mechanism initiated by the RBI. As per the Bureau for International (BIS) Settlements “Triennial Central Bank Survey 2022”, as of April 2022, USD accounts for about 88% of global foreign exchange market turnover, followed by the Euro, Japanese Yen, and Pound Sterling. The Indian rupee accounts for a mere 1.6%.
In March 2023, the RBI allowed the opening of Special Rupee Vostro Accounts (SRVAs) to put in place the mechanism forrupee trade settlement with as many as eighteen countries.It includes Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, Myanmar, New Zealand, Oman, Russia, the Seychelles, Singapore, Sri Lanka, Tanzania, Uganda, and the United Kingdom. In April 2023, India and Malaysia agreed to settle trade in Indian rupees. Amid talks towards finalising a free trade agreement with India, Bangladesh is also considering the settlement of bilateral trade in Indian rupees.
Significance
The most important advantage of internationalising the rupee is to reduce dependency on the USD for foreign trade. It would further increase the bargaining power of India in international business. Expanding the use of the rupee for international trade will reduce currency risk for Indian businesses by eliminating their exposure to currency volatility. This can reduce the cost of doing business and, hence, make exports more competitive in the global market. Additionally, the need to maintain forex reserves can be drastically reduced if a sizable share of India’s trade can be settled in terms of the domestic currency.
What are the major roadblocks to the internationalization of the rupee?
Rupee-trade arrangements are not easy to implement, which is why India and Russia have suspended efforts to settle bilateral trade in rupees after months of negotiations failed to convince the latter to keep rupees in their coffers. The rupee is not fully convertible; India's share of global exports of goods is just about 2%, and these factors reduce the necessity for other countries to hold rupees. India accounts for less than 4% of global services trade, 2.5% of global merchandise trade, and an even lower percentage of global financial activities.
Consequently, Russia wanted the trade to be done in Chinese Yuan, UAE Dirham, or other currencies. India has a trade deficit with its major trading partners, including China, the UAE, Saudi Arabia, and Russia. In fact, India’s large trade deficit vis-à-vis Russia, which implies that the latter would be saddled with large rupee balances, is also why it has been reluctant to engage in rupee-rubble trade. Balancing exchange rate stability and domestic monetary policy is one of the major obstacles to the internationalization of the rupee. As the rupee becomes more internationalised, it is likely to become more vulnerable to external economic shocks, such as changes in global interest rates or fluctuations in commodity prices. This could make it more difficult for the central bank (RBI) to maintain both exchange rate stability and a domestically oriented monetary policy.
When a currency is internationalised, both residents and non-residents can buy and sell domestic currency-denominated financial instruments such as stocks, bonds, and other securities. This means that the demand and supply of the country's currency can be influenced not just by domestic but also external factors (outside the country). If this happens in the case of the rupee, the RBI will have limited control over the money supply within its own borders, which could make it difficult to maintain stable interest rates that are in line with the requirements of the domestic economy.
For the rupee to be effectively internationalised, the government will have to remove restrictions on any entity (domestic or foreign) from buying or selling rupee; this implies no restrictions on the flow of capital in and out of the country, which would require full convertibility on the capital account. However, successive Indian governments have avoided full convertibility on the capital account to prevent the Indian economy from being exposed to the risks of external financial shocks.
What Measures Can Be Taken to Facilitate Rupee Internationalization?
Among the emerging economies, China is the only country that has been able to steadily internationalise its currency while maintaining controls on its capital account. It has done so by finalising currency swap agreements between the central banks of China and 43 other countries, which assure the markets that there will not be an oversupply of the renminbi.
Creating an offshore market for its domestic currency that allows foreign entities to sell renminbi for dollars However, it must not be forgotten that China also has a trade surplus with most of the other countries.
India needs better planning
It would require India to have considerable thinking and planning to make rupee-internationalization function in a manner that does not adversely affect the economy’s fundamentals. The government must carefully balance the benefits with the potential risks and respond appropriately to ensure the stability of the economy. It also requires India to have a large and deep domestic financial market to be better equipped to handle external shocks and make it easier for the RBI to manage its monetary policy. India has made a modest attempt at facilitating rupee trade; the idea will take time to gain acceptance.
For the time being, the rupee’s acceptance will potentially be limited to countries that have a deficit with India. India will need to enrol other trade partners that will be able to use their rupees to buy goods from India. The US and European Union are the major export destinations for India, and the others would be oil-exporting nations. Getting the latter into our fold sounds plausible. Removal of restrictions on buying and selling of domestic currency in both the spot and forward markets. Domestic firms can invoice exports and imports in their own currency. Foreign firms, financial institutions, government institutions, and individuals can hold the country’s currency and financial instruments.