Internationalization of the Indian rupee – Opportunities and Challenges

As the use of the rupee becomes more significant internationally, the bargaining power of Indian businesses will improve, adding weight to the Indian economy and enhancing India’s global stature and respect.
  • The use of the rupee in cross-border transactions mitigates currency risk for Indian businesses.
  • Reducing dependence on foreign currency makes India less vulnerable to external shocks.
  • Large holdings of such financial assets could heighten vulnerability to external shocks, whose management would necessitate more effective policy tools.
  • Non-resident holdings of rupees could exacerbate the pass-through of external stimulus to domestic financial markets, increasing volatility.
  • Opening up and liberalising settlements in rupees for various financial instruments both in India and overseas are more important.

Internationalization of the Indian rupee is a process that involves increasing the use of the local currency in cross-border transactions. It involves promoting the rupee for import and export trade, followed by other current account transactions and its use in capital account transactions. As far as the rupee is concerned, it is fully convertible in the current account but partially convertible in the capital account. Internationalization of the rupee seems inevitable due to growing confidence in the Indian economy internationally, which was possible due to reforms initiated by the Modi government. 

Need for Internationalization of the Indian rupee

The economy is growing by leaps and bounds due to the digitization drive, which led to the formalisation of the economy after demonetization and GST implementation. The Indian financial system offers deep and liquid markets, with financial institutions including banks, insurance companies, pension funds, and hedge funds offering a wide range of products in terms of borrowing, investing, and hedging. Masala bonds allow Indian corporations to raise overseas debt in Indian rupees. The rupee-dominated bonds protect the Indian entity from the risk of currency fluctuation and help in the internalisation of the rupee, which helps in the expansion of bond markets. With the Indian economy poised to achieve $5 trillion by 2027, the rupee remittance mechanism internationally is gaining acceptance through the growing popularity of the United Payment Interface (UPI) developed by NPCI. The Rupay-based payment system has gained international acceptance and is scheduled to make its European debut in France. The payment system has been adopted in the UAE, Nepal, Bhutan, and Singapore. The UPI allows ex-pat Indians to make cross-border remittances seamlessly. The UPI system has alliances with international network partners such as Discover Financial Services, Japan Credit Bureau, China Union Pay, and the Lyra Network to provide them with a global footprint for RuPay cardholders. 

The development of a robust real-time payment system (IMPS) for the domestic retail sector and the National Automated Clearing House (NACH) to facilitate a web-based system for bulk push and pull for both account-based and Aadhar-based transactions has expanded the reach of UPI widely across India. The recently unveiled Payments Vision 2025 document will enable the geotagging of digital payment infrastructure and link credit cards and credit components of banking products to UPI. The exclusion of Russia from the SWIFT-dominated US dollar global financial system is an opportunity to push for the internationalisation of the rupee. With Russia offering crude at a heavy discount, India and Russia are working towards setting up a bilateral payment system through Nostro accounts.

Similarly, India and Iran are exploring the possibility of settling trade in rupees. The Myanmar government has started currency convertibility for trade with India. The government has currency swap agreements with Venezuela, the UAE, and Japan, and the government is working towards expanding its scope to around 23 countries to save precious foreign exchange and strengthen the rupee. 

The Reserve Bank of India has introduced the Central Bank Digital Currency (CBDC), a digital version of cash backed by a central bank guarantee. The introduction of the CBDC outlines the pursuit of the RBI to introduce a new payment system based on the CBDC and reduce its reliance on dollar-based cross-border transactions. The dollar’s dominance gives the United States leverage to impose sanctions, and it forces the Society for World Wide Interbank Financial Telecommunications to comply with its diktats. The CBDC provides an opportunity to bypass the cross-border trade settlement mechanism. The need to delink from the dollar arises after G7 countries froze Russian foreign currency reserve assets worth $500 billion. Iran has lost $150 billion worth of revenue due to American sanctions. The Reserve Bank of India has adopted a calibrated approach to internationalising the rupee through limited capital convertibility. Capital controls are being liberalised according to the evolving macroeconomic conditions and requirements arising in the financial system. And with the slew of measures adopted by the Indian Government to give a boost to Atmanirbhar Bharat through PLI schemes, the country can aim for full capital convertibility to become the currency of choice to trade in international markets

Advantages of Internationalization

The use of the rupee in cross-border transactions mitigates currency risk for Indian businesses. Protection from currency volatility not only reduces the cost of doing business but also enables better growth of businesses, improving the chances for Indian businesses to grow globally. It reduces the need to hold foreign exchange reserves. While reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy. Reducing dependence on foreign currency makes India less vulnerable to external shocks. For example, during phases of monetary tightening in the US and a strengthening dollar, excessive foreign currency liabilities of domestic businesses result in a de facto domestic tightening. Reduced exposure to currency risk would substantially mitigate the pain of a reversal of capital flows.

As the use of the rupee becomes more significant, the bargaining power of Indian businesses will improve, adding weight to the Indian economy and enhancing India’s global stature and respect. In July 2022, the RBI introduced a mechanism to facilitate international trade in rupees, enabling external commercial borrowings in rupees (especially masala bonds). The Asian Clearing Union is also exploring the idea of using domestic currencies for settlement. An arrangement, whether bilateral or among trading blocs, that offers importers of each country the choice to pay in domestic currency is likely to be favoured by all countries and, therefore, is worth exploring.

Challenges in the Internationalization of the rupee

India is a capital-deficient country and hence needs foreign capital to fund its growth. If a substantial portion of its trade is in rupees, non-residents would hold rupee balances in India, which would be used to acquire Indian assets. Large holdings of such financial assets could heighten vulnerability to external shocks, whose management would necessitate more effective policy tools. A reduced role for convertible currencies in external transactions could lead to reduced reserve accretion. At the same time, however, the need for reserves would also reduce to the extent the trade deficit is funded in rupees. Non-resident holdings of rupees could exacerbate the pass-through of external stimulus to domestic financial markets, increasing volatility. For instance, a global risk-off phase could lead non-residents to convert their rupee holdings and move out of India.

The recent initiative of invoicing trade in rupees comes from a different global requirement and order, but for true internationalisation and wider use of the rupee overseas, opening up trade settlement in rupees alone will not suffice. Further opening up and liberalising settlements in rupees for various financial instruments both in India and overseas are more important. Rupee internationalisation may also require an efficient swap market and a strong foreign exchange market. Further improvement in overall economic fundamentals and financial sector health, followed by an upward movement in sovereign ratings, will also strengthen confidence in the rupee, making the currency ready for the next step in its international journey.

(The author is a Post Graduate student in International Relations at Amity University, Raipur. She writes articles and research papers regularly on international affairs and geopolitics)

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