India should move towards complete convertibility of rupee

It is nearly a year since the Reserve Bank of India (RBI) issued its AP (DIR) Circular No.10 dated July 11, 2022, allowing foreign banks to open Special Vostro Accounts (SVA) with Indian banks to facilitate settlement of trade transactions in non-convertible rupees. Although a few foreign banks have opened such accounts and a few transactions have been put through such accounts, mainly to pay for imports of crude oil from Russia, by and large most foreign banks have stayed away from the new facility and the exporters and importers in India and abroad have also preferred to continue invoicing in US dollars, euro, or any other convertible currencies rather than use Indian rupee (INR) for their transactions. In my earlier column, I had dealt with some of the reasons why the arrangement may not pick up (Read Here).
 

The RBI had constituted an Inter-Departmental group (IDG) led by Radhe Shyam Ratho, its executive director, to review the extant position of INR as an international currency and to frame a road map for internationalisation of INR. The report dated October 6, 2022, was released last Wednesday, i.e, on July 5, 2023. It is difficult to understand why it has taken nine months for the RBI to release this report.
 

The IDG views internationalisation as a continuous process involving progressive capital account convertibility, wherein the domestic currency increasingly acquires the character of a de facto freely convertible currency for international financial transactions. Drawing on the Chinese experience, the IDG notes the important role that bilateral currency swaps can play in promoting use of INR for settling foreign trade.  It says that local currency settlement (LCS) frameworks also facilitate wider use of local currencies in current and capital account transactions, thereby facilitating the ease of doing business and reducing dependence on hard currencies. 
 

The IDG feels that more measures to increase non-residents’ participation in the domestic economy, integrate onshore and offshore financial markets, and foster greater Indian participation in global trade and finance should continue to be taken.

At a time when the RBI still believes in policing each and every import and export transaction, the IDG says, somewhat surprisingly, that the current level of capital account convertibility (CAC) gives enough room for initiating steps towards internationalisation. 
 

The IDG believes that CAC is not a pre-condition for internationalisation of INR, or vice-versa, and makes several recommendations over the short-term and medium-term horizons. Providing equitable incentives to exporters for INR trade settlement is one of them.  
 

Overall, says the IDG, the benefits of internationalisation in terms of limited exchange rate risk, lower cost of capital due to better access to international financial markets, high seigniorage  benefits (the profit government makes due to the difference between the face value of a currency and the cost of producing or printing it), and reduced requirement of foreign exchange reserves far outweigh the risks of possible increased volatility in the exchange and money markets that make the conduct of monetary policy more complex.
 

Given the task and the terms of reference, the IDG had to come out with a report and it has done so. Now, it is for the RBI to evaluate the recommendations. Hopefully, it will start with liberating each export and import transaction from its monitoring systems and moving towards full convertibility of INR.

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Email: tncrajagopalan@gmail.com