Internationalising the INR will be a gradual process

In the last 10 years, the world economic prospects have declined whereas the Indian economy has managed to grow albeit at a slower pace and has been relatively resilient amidst the recent global shocks.

The Reserve Bank of India (RBI) recently released a report of an Inter-Departmental Group chaired by Radha Shyam Ratho on the internationalisation of the Indian rupee (INR). The internationalisation of the rupee has been discussed ever since RBI took some steps towards the internationalisation of the rupee in July 2022. The new IDG report gives us more ideas on the need to internationalise the INR and the process to achieve it.

First, what is an international currency? Any currency performs three functions of money: medium of exchange, store of value and unit of account. At an international level, the functions are the same but it is applied at two levels: private and official.

In the private sector, the international currency, like any national currency, should be used privately for paying for transactions, storing value and seeing the same currency unit for different goods and services. One does not wish to travel to a foreign country and get stuck on any of these functions. In the official sector, the international currency is used for strategic purposes. Governments and central banks keep international currencies as reserve assets to intervene in forex markets.

While a national currency needs to tick the three functions, an international currency needs to tick all six functions. While a government can still make a case for making a currency national, it cannot do so for making a currency international. International currencies take decades to develop and last nearly a century or more as we can see from the case of the British pound and the US dollar.

Second, why should a country care to position its currency as an international currency? Clearly, both the private and the official sectors gain as thy do not have to deal with exchange rate risks. The US exporters and importers are never worried about keeping the US dollar for international transactions. The US government is obviously never worried as it can just print and pay in USD. There is little need to keep foreign exchange reserves and so on. The borrowers also face lower costs in the case of borrowing from abroad.

All the other countries have to sweat for earning dollars via exports, which are then used to pay for imports from other countries. If a country cannot export, it has to borrow US dollars to pay for imports. If the borrowed dollars are not paid back, the country faces a crisis as seen in the case of Sri Lanka and Pakistan.

It is not that there are only gains from internationalisation. There are costs as well but much of it is again borne by other countries. The prevalence of the USD as an international currency means the Federal Reserve policies do not just impact the US but also other countries. The words of the Federal Reserve officials are tracked all around the world for cues on interest rates and the USD.

Once An International Currency

Third, what leads to the INR positioning itself as an international currency? First of all, being an international currency is not new for the rupee.  It was used widely across the Persian Gulf states. Once these states introduced their own currency in the 1960s and 1970s, the INR was withdrawn.

In the current context, the situation is more complex. The world economy has been in turmoil. The US has held sway over world politics, economics and currency for almost a century now. The rise of China and the Russia-Ukraine war have tilted the power structures considerably. There is a thinking that we need to move away from US hegemony to a more multipolar world where multiple currencies can work as international currencies.

One major precondition for internationalising a currency is that the economy should be international as well. India has made great progress since the opening of the economy in 1991. As per the IDG report, in the period 2012-22, exports have grown 1.4 times to $421.9 billion and imports have grown by 1.25 times to $612 billion. In the same period, India’s foreign exchange reserves nearly doubled to $560.4 billion and foreign direct investment has increased by 1.8 times to $84.8 billion. In the last 10 years, the world economic prospects have declined whereas the Indian economy has managed to grow albeit at a slower pace and has been relatively resilient amidst the recent global shocks. These multiple factors have made a case for internationalising the INR as well.

Accordingly, the IDG has laid a roadmap without any timelines for internationalising the INR. It has divided the recommendations into short-term and medium-term measures. The short-term measures are around encouraging private usage of the INR in trade and finance transactions. On the official front, INR usage has to be encouraged by setting up local currency settlement frameworks and even multiple currency settlement frameworks such as Asian Currency Union. India’s financial and payment markets need to be integrated with global markets. There is a long-standing matter of including Indian bonds in global indices. The medium-term measures are around harmonising taxes so that Indian and global investors can raise funds in and outside India. Indian banks should be allowed to use the INR in their off-shore branches.

Slow And Steady Process 

The IDG has also studied how different currencies — the USD, Euro (which has tried very hard to compete with the US Dollar), Australian dollar and finally Chinese renminbi — have in many ways shaken the global monetary system. There is a timeline on the Chinese renminbi’s journey towards internationalising which started in 2002 and is still an ongoing journey. It validates the point that it takes decades to build an international currency. One interesting point made by the IDG is that capital account convertibility is not a prerequisite for internationalising the rupee. This means that India can continue to open its capital account gradually and also work towards internationalising the INR.  This lesson seems to be coming from how China has gone around internationalising the renminbi without the need to fully open the capital account. But then economists would suggest that capital account restrictions are acting as an impediment towards making the renminbi a more international currency than it is currently.

Overall, the IDG report has led to ideas and thinking on not just the internationalisation of the INR but even the economy, as both are intertwined. Even if the IDG has suggested short-term and medium-term measures, most of them are going to play out over a much longer term.

Amol Agrawal teaches at Ahmedabad University. Views are personal, and do not represent the stand of this publication.