Internationalization of Rupee

Context

The RBI will permit the opening of rupee (INR) accounts outside India by persons resident outside India (PROIs) as part of the 2024-25 agenda for internationalization of the domestic currency.

About

This move will enable Indian banks to extend rupee-denominated loans to individuals residing outside India.

Additionally, the RBI will facilitate foreign direct investment and portfolio investment through specialized accounts, such as special non-resident rupee and special rupee vostro accounts.

The Rationalisation of regulations towards promoting the internationalization of the INR was undertaken to enable the settlement of bilateral trade in local currencies.

What is an International Currency?

A currency can be termed “international” if it is widely accepted worldwide as a medium of exchange.

Just like a domestic currency, an international currency performs the three functions of money – as a medium of exchange, a unit of account, and a store of value.

An international currency is used and held beyond the borders of the issuing country for transactions between residents and non-residents and between residents of two countries other than the issuing country.

What is Currency Internationalization?

Currency internationalization is the use of a currency outside the borders of its country of issue.

The level of currency internationalization for a currency is determined by the demand that users in other countries have for that currency.

This demand can be driven by the use of the currency to settle international trade, to be held as a reserve currency or a safe-haven currency, or in general use as a medium of indirect exchange in other countries’ domestic economies via currency substitution.

The US dollar has been the dominant global currency for the better part of the last century.

Its position is supported by a range of factors, including the size of the US economy, the reach of its trade and financial networks, the depth and liquidity of US financial markets, and a history of macroeconomic stability and currency convertibility.

Benefits of Currency Internationalization

Limit Exchange Rate Risk: As the internationalization of a country’s currency broadens and deepens its financial market, domestic firms are able to invoice and settle their exports/imports in their currency, thus shifting exchange rate risk to their foreign counterparts.

Access to international financial markets: It permits domestic firms and financial institutions to access international financial markets without assuming exchange rate risk.

Boost capital formation: A larger, more efficient financial sector serve the domestic non-financial sector better by reducing the cost of capital and widening the set of financial institutions that are willing and able to provide capital.

This would boost capital formation in the economy thereby increasing growth and reducing unemployment.

Finance Budget Deficit of Government: Currency internationalization allow a country’s government to finance part of its budget deficit by issuing domestic currency debt in international markets rather than issuing foreign currency instruments.

Foreign exchange reserves: It reduces the requirement for the authorities to maintain and depend on large foreign exchange reserves in convertible currencies to manage external vulnerabilities.

Repay external sovereign debt: At the macroeconomic level, internationalization of a currency results in lowering the impact of sudden stops and reversals of capital flows and enhances the ability to repay external sovereign debt.

Challenges

Conflict with domestic monetary policy: The obligation of a country to supply its currency to meet global demand may come in conflict with its domestic monetary policies, popularly known as the Triffin dilemma.

Highlight external shocks: The internationalization of a currency may accentuate an external shock, given the open channel of the flow of funds into and out of the country and from one currency to another.

Exchange rate volatility: The costs also emanate from the additional demand for money and also an increase in the volatility of the demand. With the advances in statistical reporting, most central banks can separate foreign demand for money, but with regard to some components, such as cash, uncertainty remains.

The main costs of allowing greater international use of the currency emerge from the possible increased volatility in the exchange and money markets, thus making the conduct of monetary policy more complex.

Can the Rupee become an international currency?

During the last two decades, India has emerged as one of the world’s fastest-growing economies and also a preferred destination for global investors. The Indian economy has also shown remarkable resilience against adverse global developments, especially during the COVID-19 pandemic.

There is some anecdotal evidence that INR is accepted to some extent in Singapore, Malaysia, Indonesia, Hong Kong, Sri Lanka, United Arab Emirates (UAE), Kuwait, Oman, Qatar, and the United Kingdom (UK), among others, while it is legal tender in Nepal and Bhutan.

It is argued that the bilateral currency swap arrangements may provide a blueprint for reducing the dependence on the US dollar for settling trade transactions.

China has followed a similar approach by using a large number of bilateral swaps and Lines of Credit (LoC) to encourage the use of the Renminbi for international trade transactions.

Way Ahead

Overall, the benefits of internationalization in terms of limited exchange rate risk, lower cost of capital due to better access to international financial markets, and reduced requirement of foreign exchange reserves far outweigh the concerns.

Further, as the internationalization of a currency is a long-drawn process involving continuous change and incremental progress, it would enable timely redressal of the associated concerns and challenges as we move forward.

-----------------------------------