Internationalisation of the rupee would make domestic monetary policy more challenging but the alternative of compromising on growth by playing it safe is clearly not an optimal choice, according to RBI Deputy Governor T Rabi Sankar.
“We need to calibrate our moves to the evolving size of our economy, particularly the size of the external sector and to our appetite for risk in framing policy for external trade and capital flows.
“But the direction (on internationalisation of the rupee) is clear,” Rabi Sankar said in his recent keynote address delivered at the Annual Day event of the Foreign Exchange Dealers Association of India (FEDAI) .
The Deputy Governor observed that in the case of the dollar, which is an international currency, the ‘exorbitant’ privileges include immunity from Balance of Payments crises as the USA can pay for its external deficits with its own currency.
The dominance of its financial institutions, markets and policies in the global economy, the protection for its businesses from currency risk, the seigniorage that accrues to it, all of these flow from its status as the preeminent reserve currency, he said.
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Rabi Sankar drew a distinction between the status of ‘rupee as an international currency’ and the process of ‘internationalisation’ of the rupee.
“Rupee as an international currency, with all its attendant privileges that we saw USD enjoys, is a state that lies well into the future. It is not achievable by financial regulation alone, as the preconditions we listed for dollar dominance clearly illustrate,” he said.
But India can make tangible progress towards internationalisation of the rupee, noted the Deputy Governor.
“This is a process that involves increasing use of the rupee in cross-border transactions. Broadly, the process involves promoting rupee for import and export trade and then other current account transactions followed by its use in capital account transactions.
“These are all transactions between residents in India and non-residents,” he said.
Rabi Sankar emphasised that use of rupee for transactions between non-residents would be a decisive vote of confidence in rupee’s internationalisation, but that is a step which belongs to the final stages of rupee internationalisation, and not a priority at this stage.
The Deputy Governor said India, in fact, taken the initial steps towards internationalisation of the rupee.
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Enabling external commercial borrowings in rupees (especially Masala Bonds) was one step.
Though invoicing exports and imports in rupee was long permitted, it was being resorted to for limited uses.
The July 2022 Scheme of RBI permitting rupee settlement of external trade created a more comprehensive framework, including the flexibility of investing surplus rupees in Indian bond markets.
“We are receiving encouraging response from countries to participate in rupee-based trading.
“The Asian Clearing Union is also exploring a scheme of using domestic currencies for settlement. An arrangement, bilateral or among trading blocs, which offers importers of each country the choice to pay in domestic currency is likely to be favoured by all countries, and therefore, is worth exploring,” he said.
Rabi Sankar underscored that increased use of rupee in cross-border transactions requires a unified global market in rupee both in interest rates and currencies.
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“Such unification would not only improve depth and liquidity of our markets, but they would also facilitate uniform pricing across borders.
“Accordingly, Reserve Bank has also been putting in place enabling conditions by way of linking the domestic rupee interest rates and currency markets with offshore rupee markets by enabling domestic banks to operate in the offshore markets,” he said.
Simultaneously, Primary Dealers (PDs) have been allowed market making in forex markets to improve market liquidity.
Further steps in this direction are enhancing transparency of global rupee markets through a comprehensive reporting framework.
“A desirable outcome would be if market-makers like banks and PDs centralise their global rupee book in India. Among other benefits, this would improve risk management for Indian and global firms alike and enhance the global role for India’s financial sector,” he said.
On the risks of internationalisation of the rupee, Rabi Sankar noted that India is a capital deficient country, and hence needs foreign capital to fund its growth. If a substantial portion of its trade is in rupee, non-residents would hold rupee balances in India which would be used to acquire Indian assets.
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Large holdings of such financial assets could heighten vulnerability to external shocks, managing which would necessitate more effective policy tools.
The Deputy Governor said a reduced role for convertible currencies in external transactions could lead to reduced reserve accretion. At the same time, however, the need for reserves would also reduce to the extent the trade deficit is funded in rupees.
Non-resident holdings of rupee could exacerbate pass-through of external stimulus to domestic financial markets, increasing volatility. For instance, a global risk-off phase could lead non-residents to convert their rupee holdings and move out of India.
“These risks are real, but they are unavoidable if India is to progress to be an economic superpower. Macroeconomic policy would need to measure up to such risks,” said the Deputy Governor.