International ambitions

India should go slow on rupee internationalisation

An international currency can be defined as one that can be used beyond the borders of the issuing country and can perform the basic functions as a medium of exchange, unit of account, and store of value. It brings a number of advantages for the issuing country. Its residents, for instance, can trade with non-residents in the domestic currency, which not only reduces transaction costs but also eliminates exchange-rate risks. Further, it cuts the cost of financing because funds can be raised without taking currency risks from a wider range of international investors who are willing to hold assets denominated in an international currency. For the issuing monetary authority, it means greater seigniorage and lower pressure to maintain large foreign exchange reserves. It is thus not surprising that countries aspire to be in such a position. Efforts by some countries in this direction are also driven by the desire to move away from the dollar, partly because of geopolitical reasons.

India has been taking tentative steps in this direction. The Reserve Bank of India on Wednesday released a report by an interdepartmental group, which has made several recommendations for internationalising the rupee. Economic growth and development over the past few decades, to be sure, has led to a greater integration of the Indian economy with the global economy. However, despite the notable expansion and integration, there is a strong case for India to go slow on its ambitions to internationalise the rupee. Some of the recommendations of the report could end up increasing macroeconomic risks. The report, for example, has recommended that all government securities be included under the fully accessible route and efforts should be made to get government bonds included in global bond indices. It has further argued in favour of liberalising foreign investment in the corporate debt market. While this would reduce the cost of funding, it could significantly increase volatility in the currency market.

Besides this, it would also put upward pressure on the exchange rate, which will affect India’s tradable sectors. In fact, the idea of internationalising the rupee depends to an extent on India’s ability to open up the capital account. Since India runs a persistent current account deficit, its trading partners would have a surplus rupee balance, which they would, at some point, want to convert into a hard currency because non-convertibility will restrict its further use. It is also worth noting here that internationalising a currency is not without risks. At times of higher volatility in global markets, entities holding rupees or rupee-denominated assets may want to exit, which can end up increasing the pressure on the rupee.

Notably, India has so far moved cautiously on the capital account and there is no compelling reason to change the approach. Also, the idea of internationalisation of the rupee and a greater opening up of the capital account seems contrary to the increasingly restrictive approach to the current account. The dollar remains the currency of choice for international transactions because it is backed by an open, large, and liquid market. Thus, it is important first to have the necessary tools in place before the rupee can start enabling international transactions in a significant way. Policymakers would be well advised to go slow on internationalisation and first focus on developing financial markets with strong macroeconomic fundamentals.