Internationalisation of the rupee is 'inevitable', says RBI report

Internationalisation of the rupee is “inevitable” but will complicate the formulation of the monetary policy, according to the Reserve Bank of India’s (RBI’s) report on currency and finance.

Internationalisation means the currency can be freely transacted by both resident and non-residents, and be used as a reserve currency for global trades.

It can lower transaction costs of cross-border trade and investment operations by mitigating exchange rate risk, but “makes the simultaneous pursuit of exchange rate stability and a domestically oriented monetary policy more challenging, unless supported by large and deep domestic financial markets that could effectively absorb external shocks”.

“Internationalisation can potentially limit the ability of the central bank to control domestic money supply and influence interest rates as per domestic macroeconomic conditions,” the report said, adding, besides deep and sophisticated financial markets, the most important prerequisite for internationalisation of a currency is price stability.

The inflation rate, which is higher than the world average, undermines the use of the currency as an international medium of exchange and a store of value and can “restrict the role of such an economy in global value chains”.

On the contrary, stable prices build confidence of international investors in the domestic currency.

In this context, the primary focus of flexible inflation targeting framework on price stability augurs well for further liberalisation of the capital account and internationalisation of the rupee, it said.

The report suggested the RBI carefully monitor the exchange rates as a key information variable for monetary policy formulation as “inflation can still alter by 10-13 per cent of the change in exchange rate”.

The report also mentioned the need to use the standing deposit facility (SDF), which absorbs liquidity without offering collaterals, as a sterilisation tool.

The SDF as a liquidity absorption tool is long awaited by market participants, and RBI Governor Shaktikanta Das has indicated in the past that it is an option available with the central bank if there was a need.