Internationalising the rupee: India's path must diverge from China

At its last policy meeting, the Reserve Bank of India (RBI) unveiled several measures to boost the rupee’s use in cross-border trade — a step towards its gradual internationalisation. The notion that an emerging economy’s currency can gain global traction took off after the International Monetary Fund added China’s renminbi (RMB) to its special drawing rights basket in 2016. Now, amid renewed geopolitical tensions involving the United States, Russia, and China, the question resurfaces: How can India meaningfully advance the rupee’s journey towards international status?

 

For the rupee to become an international currency, non-residents must both want and be able to trade and invest in it. A Russian importer, for instance, should be able to pay for South African goods in rupees. Likewise, an investor in the United Kingdom (UK) should be able to buy rupee-denominated bonds or shares with ease. In these cases, foreigners —not Indians — bear the currency risk. That shift is the essence of true currency power. It’s also the “exorbitant privilege” the US dollar has long enjoyed. 

The willingness and ability to use a currency globally rest on three key conditions. First, the issuing economy must have scale — measured by gross domestic product (GDP), trade flows, and volume of international transactions. China, with an $18 trillion economy, meets this bar; India, at around $4 trillion, does not yet. To build that scale, India must sustain a growth rate of 7–8 per cent annually over the coming years — a difficult but necessary condition for the rupee’s global ambitions.

 

Second, the value of the currency must be stable over time. A currency is considered stable when the general level of prices does not vary too much. Stability has multiple aspects: Macroeconomic, financial, and political. On the macroeconomic front, India has done well. The consumer price index-based inflation is at multi-year lows, and the RBI has built credibility in keeping it close to the 4 per cent target. Financial stability, too, has strengthened: Banks are better capitalised, balance sheets are cleaner, and the broader financial system appears sound.

 

Political stability is the third pillar. The fact that India is a democracy, goes in its favour. Democracy, with its institutional checks and balances, reassures foreign investors about policy credibility and continuity. That confidence, in turn, lends long-term stability to the currency.

 

Currency stability is often mistaken for the absence of volatility — but the two are not the same. A stable currency reflects true market forces, not central bank management. Its value should be shaped by cross-border capital flows, much like the dollar-euro exchange rate, which stays broadly stable despite constant movement in global finance. Think of it like administered prices: India once controlled the prices of essentials like steel and diesel, keeping them artificially steady. Today, those prices fluctuate with supply and demand — and that’s a sign of a healthy market. Currency markets should work the same way. 

Finally, a currency must be liquid — meaning investors can buy and sell large amounts of assets in it without moving prices. Liquidity depends on deep financial markets and an open capital account. India’s equity market is vibrant, but its debt market remains shallow. History shows that countries with capital controls tend to have thinner markets, while openness to foreign investors boosts liquidity. Yet, more than three decades after liberalisation began, India still maintains extensive controls  —  especially in its debt and derivatives markets — limiting the rupee’s global reach.

 

This is where India’s approach must differ sharply from China’s. Beijing has sought to internationalise the RMB while retaining capital controls and a tightly managed exchange rate — a combination no currency has ever succeeded with. China’s advantage lies in scale: It commands over 12 per cent of global trade, and in some products, more than half of world exports. That dominance allows it to partially offset the constraints of limited convertibility. India, with only about 3 per cent of global trade, lacks that leverage. The contrast shows in the data — the RMB accounts for nearly 9 per cent of global foreign exchange turnover, while the rupee lags below 2 per cent.

 

India’s best path forward is to gradually ease its capital controls. The RBI and the government have taken meaningful steps since 2020, but more are needed. Alongside this, India should embrace a genuinely flexible exchange rate while ensuring ample hedging options for market participants. Encouragingly, progress is visible: From the near-pegged regime of 2022–24, when rupee-dollar volatility hit record lows, the RBI has since allowed the currency to move more freely with market forces.

 

Of course, India cannot liberalise the capital account or adopt a fully flexible exchange rate overnight. One promising approach is to use GIFT City, the International Financial Services Centre, as a controlled experiment. It could become India’s “Hong Kong,” with an open capital account, flexible exchange rates, and robust hedging instruments. The RBI could gain valuable experience managing such a system, gradually scaling it up to advance the rupee’s journey towards international status.

 

Making the rupee an international currency aligns with India’s vision of becoming an advanced nation by 2047. But achieving this over the next two decades will demand sustained, deliberate action. Currency internationalisation is a long journey, requiring multiple building blocks. Indian policymakers must chart a path distinct from China’s, steadily dismantling the barriers that limit the rupee’s global role. Success will hinge on a steadfast commitment to economic reforms that inspire international confidence in the currency.

 

 

The author is associate professor of economics, IGIDR, Mumbai. The views are personal