An important prerequisite for internationalising a currency is an internationally integrated economy. India has achieved significant advancements since the opening of its economy in 1991.
The global economic outlook has deteriorated over the past decade, whereas the Indian economy has managed to develop, albeit at a slower rate, and has been relatively resilient in the face of recent global shocks.
The Reserve Bank of India (RBI) recently published a report on the internationalisation of the Indian rupee (INR) by an Inter-Departmental Group convened by Radha Shyam Ratho. Since RBI made steps towards the internationalisation of the rupee in July 2022, the internationalisation of the rupee has been discussed. The new IDG report provides additional insight into the need to internationalise the INR and the means to do so.
Initially, what is a foreign currency? Any given currency serves as a medium of exchange, a store of value, and a unit of account. On a global scale, the functions are identical, but they are administered at two different levels: private and official.
As with any national currency, the international currency should be used in the private sector for paying for transactions, storing value, and observing the same currency unit for various products and services. One does not desire to travel abroad and become unable to perform any of these tasks. The international currency is utilised for strategic purposes in the official sector. Governments and central banks maintain international currencies as reserve assets in order to intervene in the foreign exchange market.
A national currency must fulfil three functions, while an international currency must fulfil all six. While a government can still make a case for nationalising a currency, it cannot do so for internationalising a currency. As exemplified by the British pound and the United States dollar, the development of international currencies takes decades and lasts nearly a century.
Why should a nation position its currency as an international currency? Clearly, both the private and public sectors benefit when exchange rate risks are eliminated. US exporters and importers are never concerned about the dollar's continued use in international transactions. The United States government has no cause for concern, as it can simply print and spend dollars. There is little requirement to maintain foreign exchange reserves and the like. In the case of borrowing from abroad, the debtors will incur reduced costs.
All other nations must work hard to earn dollars through exports, which are then used to pay for imports from other nations. If a country is unable to export, it must borrow dollars in order to pay for imports. Similar to Sri Lanka and Pakistan, the country will face a crisis if the borrowed dollars are not repaid.
There are not only advantages to internationalisation. However, the majority of these costs are again borne by other nations. Due to the USD's prominence as an international currency, Federal Reserve policies affect not only the United States but also other nations. The words of Federal Reserve officials are monitored globally for clues regarding interest rates and the USD.
Thirdly, what factors contribute to the INR becoming an international currency? The rupee's status as an international currency is not novel. It was extensively utilised throughout the Persian Gulf states. In the 1960s and 1970s, when these nations introduced their own currency, the INR was withdrawn.
The situation is more complex in the present setting. The global economy has been turbulent. The United States has dominated international politics, economics, and currency for nearly a century. The rise of China and the Russia-Ukraine conflict have significantly shifted the power structures. There is a belief that we must transition from US hegemony to a multipolar world in which multiple currencies can function as international currencies.
An important prerequisite for internationalising a currency is an internationally integrated economy. Since unleashing its economy in 1991, India has made substantial progress. According to the IDG report, between 2012 and 2022, exports increased by 1.4 times to $421,9 billion while imports increased by 1.25 times to $612 billion. During the same time period, India's foreign exchange reserves increased to $560,4 billion and foreign direct investment increased to $84.8 billion by a factor of 1.8. The global economic outlook has deteriorated over the past decade, whereas the Indian economy has managed to develop, albeit at a slower rate, and has been relatively resilient in the face of recent global shocks. Multiple factors have bolstered the case for internationalising the INR.
As a result, the IDG has established a road map for internationalising the INR that does not include specific dates. The recommendations are separated into short-term and medium-term measures. Short-term measures encourage the private use of the INR in trade and financial transactions. On the official level, INR usage must be promoted through the establishment of local currency settlement frameworks and even multiple currency settlement frameworks, such as the Asian Currency Union. India must integrate its financial and payment markets with global markets. Inclusion of Indian bonds in global indices has been an issue for a long time. The medium-term measures revolve around tax harmonisation so that Indian and international investors can raise capital in and outside of India. It should be permitted for Indian institutions to use the INR in their overseas branches.
The IDG has also studied how various currencies, including the USD, Euro (which has tried very hard to compete with the USD), Australian dollar, and Chinese renminbi, have in various ways shook up the global monetary system. There is a timeline for the Chinese renminbi's internationalisation voyage, which began in 2002 and is still ongoing. It demonstrates that it takes decades to establish a global currency. An intriguing point made by the IDG is that capital account convertibility is not necessary for the internationalisation of the rupee. This means India can continue to gradually open its capital account and also strive to internationalise the INR. This lesson appears to be derived from China's efforts to internationalise the renminbi without completely opening its capital account. However, economists would argue that capital account restrictions prevent the renminbi from becoming a more international currency than it is currently.
Overall, the IDG report has stimulated ideas and thought not only regarding the internationalisation of the INR but also the economy, as the two are interdependent. Even though the IDG has proposed short- and medium-term measures, the majority of them will have a much extended duration.
Comments