Internationalisation of the Rupee: Is it time to shift gears?1
Good Evening. It gives me great pleasure to be part of the Annual Day
event of the Foreign Exchange Dealers Association of India (FEDAI).
Since its inception in 1958, FEDAI has played a crucial role in the smooth
conduct of foreign exchange business and development of forex markets.
This role assumes greater significance in today's age of rapidly evolving
forex markets and innovations in financial products and instruments.
2. The global situation continues to experience uncertainty on multiple
fronts, be it economics, geopolitics, or climate related. Coming close on
the heels of the Covid-19 pandemic, these challenges have caused the
plates of both policymakers and market participants alike to be full. I
would, therefore, like to take this opportunity amidst this august gathering
to share some thoughts on the progress of the Indian Rupee (INR) on the
path of greater acceptance in international markets, or
"internationalisation", its benefits and risks and conclude by offering a few
suggestions which might aid the Rupee's onward journey. Before
proceeding, it might be a good idea, however, to do a quick recap of the
journey of Rupee markets thus far which will set the backdrop for our main
theme of Rupee internationalisation.
3. The early stages of foreign exchange management in the country
emphasized on control of foreign exchange by regulating demand due to
its limited availability. Various controls were imposed on forex transactions
through the Foreign Exchange Regulation Act (FERA) of 1947, which was
subsequently replaced by a more comprehensive and rigorous framework
through FERA, 1973. The approach to external sector management
underwent a paradigm shift in the 1990s driven by the economic reforms
introduced in 1991. In line with the recommendations of the High-Level
Committee on Balance of Payments (Chairman: Dr C Rangarajan, 1993),
exchange rate of rupee was made market determined in 1993. In 1994,
India accepted Article VIII of the Articles of Agreement of the International
Monetary Fund (IMF) making INR fully convertible on the current account.
With enactment of the Foreign Exchange Management Act (FEMA) in
1999 to replace FERA, the approach shifted from that of conservation to
the management of foreign exchange through facilitation of external
payments.
4. During the last three decades, India's external sector has shown
remarkable progress. India's economy has increasingly integrated with
the global economy. India has emerged as one of the world's fastest
growing economies and a preferred destination for global investors.
India's trade (exports and imports together), barring the hiccup caused by
the Pandemic, has continued to grow and crossed the USD one trillion
mark for the first time during FY 2021-22 (Chart 1)2.
India's Merchandise Trade
Chart 1: India's Merchandise Trade
(In USD bn)
FY Exports Imports
700
2012-13 307 502
600
2013-14 319 466
500
2014-15 317 461
400
billion
2015-16 266 396
300
USD
2016-17 280 393
200
2017-18 309 469
100
2018-19 337 518
0
2012-13 2014-15 2016-17 2018-19 2020-21
2019-20 320 478
Exports Imports
2020-21 296 398
5. On the other hand, India's share in global merchandise trade3, while
growing, continues to be relatively modest (Chart 2).
Calenda Share in Share in
Chart 2: India's share in global
r Year Exports Imports
merchandise trade
2015 1.6% 2.4%
4.0%
2016 1.6% 2.2%
3.0%
2017 1.8% 2.7%
2.0%
2018 2.0% 3.1%
2019 2.0% 2.9%
1.0%
2020 1.7% 2.3%
0.0%
2015 2016 2017 2018 2019 2020 2021
2021 2.4% 3.5%
Share in Exports Share in Imports
6. Coming to capital flows, foreign direct investment (FDI4, Chart 3), the
preferred type of foreign capital, shows a healthy upward trend while
foreign portfolio investment (FPI5), given its very nature, shows a mixed
trend. Overseas Investments6 (OI) by Indian residents seem to have
consolidated. It is hoped that the new Rules and Regulations governing
OI will spur the global ambitions of the widely recognized Indian
entrepreneurial class.
Inbound (USD bn) Overseas Investment (USD bn)
Guarantee
Year FDI FPI Equity Loan
Invoked
2012-13 22.42 31.05 7.99 4.44 0.04
2013-14 24.30 NA 10.99 3.28 0.05
2014-15 29.74 45.70 4.78 3.18 0.06
2015-16 40.01 -2.52 8.61 4.00 0.17
2016-17 43.48 7.60 10.75 4.52 0.49
2017-18 44.86 22.47 10.11 3.74 3.21
2018-19 44.37 -5.50 8.72 4.00 1.20
2019-20 49.98 -3.04 6.80 5.70 0.74
2020-21 59.64 36.18 8.04 6.96 0.06
2021-22 55.66 -16.02 9.71 7.67 0.30
3
Source: stats.wto.org
4
FDI Data - FDI factsheet published by DPIIT
5
NSDL website
6
RBI's OID Portal
Chart 3: Foreign Investment
120.00
100.00
80.00
60.00
billion
40.00
20.00
USD
0.00
-20.00
-40.00
FDI FPI
7. External Commercial Borrowings (ECB7, Chart 4) vary from year to
year, and appear to be sensitive to interest differentials.
ECB (USD bn)
Chart 4: External Commercial Borrowing
Gross Gross Net
Year 60.00
Inflow Outflow inflow
50.00
2012-13 28.10 5.81 22.29
40.00
2013-14 29.39 9.84 19.55
30.00
2014-15 29.29 20.77 8.52
billion
2015-16 23.24 26.42 -3.18
20.00
USD
2016-17 21.24 25.84 -4.60
10.00
2017-18 27.09 24.84 2.25
0.00
2018-19 32.11 18.75 13.36
-10.00
2019-20 47.84 17.88 29.95
2020-21 33.58 29.58 4.00
Gross Inflow Gross Outflow Net inflow
2021-22 34.19 21.01 13.18
8. Outflow under the Liberalised Remittance Scheme (LRS8) is showing a
healthy trend (Chart 5) reflecting the underlying growth in the Indian
economy and is predominantly used for current account transactions.
7
dbie.rbi.org.in
8
dbie.rbi.org.in
Year LRS (USD bn)
Chart 5: LRS Outflow
2012-13 1.21
25.00
2013-14 1.09
20.00
2014-15 1.33
2015-16 4.64
15.00
billion
2016-17 8.17
10.00
2017-18 11.33
USD
2018-19 13.79
5.00
2019-20 18.76
0.00
2020-21 12.68
2021-22 19.61
9. India has always been a major recipient of private transfers9 (Chart 6),
originated by the Indian diaspora. These remittances continue to grow
over time, although their share in global inward remittances has been
moving down (from 13.9% to 12.6% in 202010).
Private Transfers (In USD billion)
Credit Debit
Financial
(Inward (Outward Net
Year
Remittances) Remittances)
2012-13 67.63 3.28 64.34
2013-14 69.64 4.16 65.48
2014-15 69.82 3.56 66.26
2015-16 65.59 2.45 63.14
2016-17 61.30 4.72 56.57
2017-18 69.13 6.18 62.95
2018-19 76.40 5.79 70.60
2019-20 83.19 6.98 76.22
2020-21 80.19 5.75 74.44
2021-22 89.13 7.90 81.23
9
dbie.rbi.org.in
10
World Bank data
Chart 6: Private Transfers
100.00
80.00
60.00
billion
40.00
USD
20.00
0.00
Credit Debit Net
(Inward Remittances) (Outward Remittances)
10. Finally, In the last decade, India's foreign exchange reserves11 (Chart
7) have grown from USD 293.9 billion in September 2012 to USD 537.5
billion in September 2022. Our forex reserves played a critical role in
cushioning the impact of severe turmoil witnessed in the global markets
in recent months. Reserves continue to be healthy and complement the
strong macroeconomic fundamentals of the Indian economy.
Chart 7
As of FY In USD bn
2012-13 292.0
2013-14 304.2
2014-15 341.6
2015-16 360.2
2016-17 370.0
2017-18 424.5
2018-19 412.9
2019-20 477.8
2020-21 577.0
2021-22 607.3
With the above brief background let us now examine the prospects of
internationalizing the Rupee.
The Case for Rupee as an international currency
11. An international currency is one that is freely available to non-
residents, essentially to settle cross-border transactions. It is an
expression of external credibility in the currency as well as in the
economy. All truly international currencies belong to large, advanced
economies. Their use for international transactions confers substantial
economic privileges to the host countries. In the case of the Dollar, the
'exorbitant12' privileges include immunity from BoP 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.
12. Clearly, one or only a few countries can enjoy such privileges at any
given point of time in history. And the preconditions - size of the economy
and a dominant share of global GDP, globally dominant businesses,
extraordinary military capabilities etc. limit the prospects of owning an
international currency to any but the largest few economies. If that is the
case, why am I talking of internationalisation of the Rupee? I would like
to clarify this point by drawing 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. Therefore, the status of
Rupee as an international currency is not what we are discussing here
today.
13. But we can make tangible progress towards internationalisation of the
Rupee. 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. 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.
14. Why do I think internationalisation of the Rupee is a desirable objective
of public policy? Some of the advantage are fairly obvious, as explained
below:
i. Use of Rupee in cross-border transactions mitigates currency risk
for Indian business. Protection from currency volatility not only
reduces cost of doing business, it also enables better growth of
business, improving the chances for Indian business to grow
globally.
ii. It reduces the need for holding foreign exchange reserves. While
reserves help manage exchange rate volatility and project external
stability, they impose a cost on the economy. For example, there is
a general agreement that India's reserves are borrowed funds.
Banks and corporate incur external debt at market rates which are
then invested in Government securities issued by advanced
economies (AEs). The rate at which external debt is incurred is
substantially higher than the return on reserves,. Assuming an
interest differential of 2%, on a Reserve base of say USD 600 billion,
the cost of reserves would work out to USD 12 billion, annually. This
cost represents a transfer of income from India to AEs. Reducing
the requirement of reserves would save some of this this loss of
income.
iii. Reducing dependence on foreign currency makes India less
vulnerable to external shocks. For example, during phases of
monetary tightening in US and strengthening dollar, excessive
foreign currency liabilities of domestic business results in a de facto
domestic tightening. The 'Taper Tantrum' episode in 2013 and the
currency volatility experienced by most emerging market economies
(EMEs) in recent months exemplify such risks. Reduced exposure
to currency risk would substantially mitigate the pain of reversal of
capital flows.
iv. As the use of Rupee becomes significant, the bargaining power of
Indian business would improve adding weight to the Indian
economy, enhancing India's global stature and respect.
15. How do we go about the process of internationalisation of the Rupee?
We have, in fact, taken the initial steps. Enabling external commercial
borrowings in Rupees (especially Masala Bonds) was one step. Though
invoicing export and import in Rupees 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.
16. As increased use of Rupee in cross-border transactions requires a
unified global market in Rupee both in interest rates and currencies. 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. Concomitantly, 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 centralize 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.
17. We have so far discussed the advantages. Let us know consider the
risks.
i. 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. Large holdings of such
financial assets could heighten vulnerability to external shocks,
managing which would necessitate more effective policy tools.
ii. 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.
iii. Non-resident holdings of Rupees 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.
18. 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. Internationalisation would make domestic
monetary policy more challenging but the alternative of compromising on
growth by playing it safe is clearly not an optimal choice. 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 is clear.
***