The recent announcement by the Indian government regarding a long-term road map for the internationalisation of the rupee holds great promise. Looking back at the history of the rupee, we see that it was widely accepted in Gulf countries during the 1950s. However, certain events, such as currency devaluation and policy changes, led to a decline in confidence. The demonetisation of 2016 further impacted trust in the rupee, especially in neighboring countries like Bhutan and Nepal. Recognizing the concerns expressed by India’s neighbors is crucial as the rupee seeks to establish its international presence. While the road to internationalisation may seem challenging, several reforms and lessons from China’s experience with the Renminbi can guide the way.
Limited International Demand
The rupee still has a long way to go in terms of internationalisation. Its daily average share in the global foreign exchange market is around 1.6%, despite India’s significant share in global goods trade at approximately 2%. Although efforts have been made to promote the rupee’s internationalisation, such as enabling external commercial borrowings and encouraging rupee transactions with select countries, the volume of such transactions remains limited. For instance, India continues to buy oil from Russia in dollars, and negotiations with Russia to settle trade in rupees have faced challenges. Russian banks have expressed concerns about currency depreciation risks and a lack of awareness among traders regarding local currency facilities. The current international demand for trading in the Indian rupee is relatively low.
Learning from China’s Experience
China’s successful internationalisation of the Renminbi provides valuable lessons. Before 2004, the Renminbi could not be used outside China, but gradually, China opened up opportunities. By 2007, financial institutions in Hong Kong were allowed to issue dim sum bonds, and trade finance and select investment transactions began using the Renminbi. Currency swap agreements were signed with various countries, and the Shanghai Free Trade Zone facilitated free trading between non-resident onshore and offshore accounts. Over time, the Renminbi gained reserve currency status, reaching a share of approximately 2.88% in international reserves by Q2 2022.
Reforms to Internationalise the Rupee
To enhance the internationalisation of the rupee, several important reforms should be pursued:
- Full Convertibility: The rupee should be made more freely convertible, with the goal of achieving full convertibility by 2060. This would allow financial investments to move freely between India and other countries, making the rupee more attractive and liquid.
- Deeper Rupee Bond Market: The Reserve Bank of India (RBI) should focus on developing a deeper and more liquid rupee bond market. This would provide foreign investors and Indian trade partners with increased investment options in rupees, fostering international use.
- Encourage Rupee Invoicing: Indian exporters and importers should be encouraged to invoice their transactions in rupees. Simplifying trade settlement procedures for rupee import/export transactions would facilitate the growth of the rupee’s international usage.
- Expand Currency Swap Agreements: Additional currency swap agreements, like the one with Sri Lanka, would enable India to settle trade and investment transactions in rupees without relying solely on reserve currencies like the dollar.
- Tax Incentives and Stable Currency Management: Offering tax incentives to foreign businesses operating in India that use the rupee would incentivize its adoption. The RBI and the Ministry of Finance must ensure stable currency management, including consistent and predictable issuance and retrieval of notes and coins, and improvements in the exchange rate regime to build confidence.
- Increase International Recognition: Advocacy for making the rupee an official currency in international organizations would enhance its profile and acceptance globally.
- Implement Tarapore Committee Recommendations: The recommendations of the Tarapore Committees, including reducing fiscal deficits, managing inflation rates, and addressing non-performing assets in the banking sector, should be pursued to strengthen the rupee’s stability and credibility.
Conclusion
The government’s road map for the internationalisation of the rupee holds significant potential for Indian businesses to expand globally and enhance the rupee’s liquidity and financial stability. However, challenges such as limited international demand and concerns from neighboring countries must be carefully addressed. By implementing comprehensive reforms, including full convertibility, developing a deeper rupee bond market, encouraging rupee invoicing, and expanding currency swap agreements, India can strengthen the rupee’s international presence. Stable currency management, tax incentives, and advocacy for international recognition are also essential. Achieving a balance between convertibility and exchange rate stability will be crucial, and establishing predictable currency management policies is of utmost importance.
