The exchange of foreign currencies goes back to early human civilisation and the advent of trade routes and commerce. In the 1950s, the Indian rupee was widely used as legal tender in the United Arab Emirates, Kuwait, Bahrain, Oman, and Qatar. However, the devaluation of India’s currency by 1966 led to the introduction of sovereign currencies in these countries to reduce reliance on the Indian rupee.
From the end of the Second World War till August 1971, the US Dollar and Sterling Pound were major international currencies. On 15th August 1971, President Nixon announced the de-linking of the US dollar with Gold. Post-delinking of the Dollar with Gold, slowly but steadily the German Mark and Japanese Yen also began to compete with the then leading currencies US Dollar and British Pound.
The Petroleum Crisis of 1974 exacerbated the problems of currencies with many countries resorting to floating and competitive devolution of the currencies. RBI made the Indian rupee fully convertible in current account transactions related to goods and services in 1994. Full convertibility implies that one can buy any foreign currency by exchanging the Indian rupee in the international market without any prior approval from the central authority.
Internationalising the Rupee can enhance India's geopolitical influence. It can strengthen economic ties with other countries, facilitate bilateral trade agreements, and promote diplomatic relations. Triffin dilemma could manifest as a conflict between maintaining stability in India's domestic economy and meeting the global demand for the Rupee.
Balancing these conflicting demands presents a challenge in the process of making the Rupee an international currency without adversely impacting the country's economic stability. It describes the conflict between a country's domestic monetary policy goals and its role as an international reserve currency issuer.
The dollar being the only accepted currency everywhere in the globe, its importance and strengthening is incessant given that Asian markets discussed the need for other currencies as viable alternatives to the US dollar. The joint statement of the BRICS Ministers of Foreign Affairs and International Relations released after the meeting (Brazil, Russia, India, China and South Africa) in Cape Town, South Africa, on June 1, 2023, underscored the importance of encouraging the use of local currencies in international trade and financial transactions among its members as well as with their trading partners.
IMF identified the Indian rupee (INR) as a potential international currency alongside China's RMB (renminbi). Accepted international currency means the Indian rupee has to be freely used in transactions by residents and non-residents and as a reserve currency for global trade. All export and import transactions are to be invoiced in Indian rupees. It would also be used to facilitate capital-account transactions. The benefits of the internationalisation of the Indian rupee are multiple.
On July 5, 2023, the Reserve Bank of India’s (RBI)'s Inter-Departmental Group (IDG) presented a roadmap for internationalising India’s currency. India has also enabled capital-account transactions, such as permitting corporate entities to raise resources through external commercial borrowings and Masala bonds (rupee-denominated bonds issued by Indian entities outside India).
The significance of the rupee for international trade settlement gained more attention with the RBI’s scheme of July 2022, permitting rupee settlement of external trade by creating a more comprehensive framework, including the flexibility of investing surplus rupees in Indian bond markets. India had a fixed Rupee-Rubble relationship in the Soviet Communist era.
That relationship was abandoned after the disintegration of the Soviet Union. In December 2022, India pioneered its first settlement of foreign trade in rupees with Russia as part of the International Trade Settlement in Indian Rupees (INR) mechanism initiated by the RBI. This milestone transaction is slated to save dollar outflows estimated at $30 billion on crude oil imports.
Invoicing and settlement of international trade transactions in Indian rupees with oil-exporting countries or countries with which India has trade deficits will lead to reductions in India's current account deficit (CAD) and reduce the burden of maintaining large foreign-exchange reserves a cascading benefit. RBI permitted banks from 22 countries to open Special Vostro Rupee Accounts (SVRAs) for settling payments in Indian rupees. This action will help Indian traders make payments in rupees for all imports, while Indian exporters will be paid from the balances in the designated Vostro accounts.
An agreement was signed between India and Iran to undertake eligible trade transactions using the Indian rupee. As per the Arrangement for Bilateral Trade Payments between India and Iran (2018), the Indian rupee Vostro accounts of Iranian banks are credited 100 per cent in Indian rupees by Indian importers against invoices payable for the supply of goods and services from entities in Iran. Cuba and Luxembourg are also interested in rupee-based trade settlements. But India is largely a net importer, and the value of the Indian rupee against the dollar has been declining historically.
Indian rupee is accepted to some extent in Singapore, Malaysia, Indonesia, Hong Kong, Sri Lanka, the United Arab Emirates (UAE), Kuwait, Oman, Qatar and the United Kingdom, among others. Central banks of Nepal, Bhutan and Malaysia also hold Government of India securities and treasury bills. India currently has a bilateral swap arrangement (BSA) with Japan for up to US $75 billion as a backstop line of support in case of any balance-of-payments issues.
Bilateral currency swap arrangements may provide blueprints for reducing dependence on the US dollar for settling trade transactions, leading to exchange-rate stability and minimising liquidity mismatches. As stated in the IDG report, India needs a standardised approach and must be prepared to engage with interested central banks for local currency settlements, swaps and line of credit (LCs).
Further, the RBI, in collaboration with the National Payments Corporation of India (NPCI), is reaching out to jurisdictions to increase the global outreach of the UPI system to facilitate cross-border transactions, including remittances. India’s retail payment system, Unified Payments Interface, and Singapore’s equivalent network, PayNow, were integrated on February 21, 2023.
This linkage allows users from both countries to access faster and more cost-efficient cross-border remittances. Similarly, on July 15, 2023, the RBI signed a MoU to set up a framework to use local currencies for cross-border transactions between India and UAE.
The broader objective the IDG envisages is that, as the payment system is leveraged for cross-border trade transactions, it ultimately enables the development of an Indian Clearing System (ICS) along similar lines.
Asian Clearing Union (ACU) proposed using the local currencies of its members for settling ACU transactions, thus mooting the idea of the Indian rupee being included as one of the settlement currencies. The proposed expansion of the ACU would further this process by encompassing more countries, increasing the geographical reach of the ACU mechanism. If India has trade surpluses with other ACU countries, it acquires the currencies of those other countries, which may be deployed in the financial markets of the respective countries.
All this may not challenge the dollar’s dominance but India’s growing geopolitical leverage and prospective economic growth, as projected by several international agencies will certainly make the Indian rupee an accepted international currency in the years to come. The Tarapore Committee's recommendations including reducing fiscal deficits, inflation rates, and banking non-performing assets, should be pursued as a primary step towards the internationalisation of the rupee. Also, advocating for the rupee to become an official currency in international organisations would raise its profile and acceptance.
As with Sri Lanka, India has to allow to settle trade and investment transactions in rupees, without resorting to a reserve currency such as the dollar. India should avoid sudden or drastic changes such as devaluation or demonetisation that can impact confidence. At the same time ensure consistent and predictable issuance/retrieval of notes and coins.
