The Reserve Bank of India (RBI) has recently released a report on the internationalization of the Indian rupee (INR). The report sheds light on the need to make the INR an international currency and outlines the process for achieving this goal.
To understand the concept of an international currency, it’s important to know that any currency serves three functions: medium of exchange, store of value, and unit of account. At an international level, these functions apply to both private and official sectors. In the private sector, an international currency should be used for transactions, storing value, and as a common unit for goods and services. In the official sector, governments and central banks hold international currencies as reserve assets for strategic purposes and intervention in foreign exchange markets.
Becoming an international currency involves fulfilling all six functions, which requires time and sustained development. The process of making a currency international takes decades, as seen in the cases of the British pound and the US dollar, which have served as international currencies for a century or more.
There are significant advantages for a country in positioning its currency as an international currency. Both the private and official sectors benefit from reduced exchange rate risks. For example, US exporters and importers don’t have to worry about using the US dollar for international transactions, and the US government can easily print and pay in USD. This eliminates the need for large foreign exchange reserves and reduces borrowing costs. In contrast, countries without an international currency must earn dollars through exports or borrow them for imports, which can lead to financial crises if the borrowed dollars cannot be repaid.
India’s progress in opening its economy since 1991 has laid the foundation for the internationalization of the INR. The country has witnessed growth in exports, imports, foreign exchange reserves, and foreign direct investment. Despite global shocks, the Indian economy has shown resilience and relative growth compared to the declining global economic prospects. These factors make a strong case for internationalizing the INR.
The report suggests short-term and medium-term measures for the internationalization process. In the short term, the focus is on encouraging private usage of the INR in trade and finance transactions, establishing local currency settlement frameworks, integrating India’s financial and payment markets with global markets, and including Indian bonds in global indices. The medium-term measures include harmonizing taxes to facilitate fundraising by Indian and global investors, both within and outside India, and allowing Indian banks to use the INR in their offshore branches.
The report also examines the experiences of other currencies, such as the US dollar, euro, Australian dollar, and Chinese renminbi, in shaping the global monetary system. It highlights that the internationalization of a currency is a gradual process that takes time. Importantly, the report suggests that capital account convertibility is not a prerequisite for internationalizing the rupee, drawing lessons from China’s efforts to internationalize the renminbi while maintaining restrictions on capital account convertibility.
In conclusion, the RBI report provides insights into the need and process for internationalizing the INR. India’s progress in opening its economy and its relative resilience in the face of global shocks make a strong case for the internationalization of the INR. The report recommends short-term and medium-term measures to encourage the usage of the INR in international transactions, integrate Indian financial markets globally, and harmonize taxation policies. While the process of internationalization will take time, the report emphasizes the importance of gradual progress in achieving this goal.