INTERNATIONALIZATION OF RUPEE 

Recently, Prime Minister asked the Reserve Bank of India (RBI) to prepare a 10-year strategy to make the Indian rupee a globally accessible and acceptable currency, enabling its internationalization. 

About internationalization of currency 

• An international currency is one that is used and held beyond the borders of the issuing country, not merely for transactions with that country’s residents, but also, for transactions between non-residents. 
• Currency internationalization has thus been described as the international extension of a national currency’s three basic functions of serving as a unit of account, medium of exchange and store of value. 
• Currently, the US dollar, the Euro, the Japanese yen and the pound sterling are the leading reserve currencies in the world. 
• India moved toward partial convertibility in the late 1990s and made subsequent progress with multiple reforms. 
  • India has 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). 

Determinants of the internationalization of currency:

• Economic fundamentals such as economy’s size and trade network. (Represented by an icon showing a graph or chart)
• Depth and liquidity of capital markets. (Represented by an icon showing coins or currency)
• Stability and convertibility of currency. (Represented by an icon showing exchange or conversion)

Benefits of Internationalization of Currency 

• Limit exchange rate risk: It allows the country’s exporters and importers to limit exchange rate risk as domestic firms can settle their exports/imports in their currency. 
• Access to international financial markets: It permits domestic firms and financial institutions to access international financial markets without assuming exchange rate risk. 
• Boost capital formation: A larger, efficient financial sector reduces capital cost and widens set of financial institutions. 
• Financing budget deficit: It may allow a country’s government to finance part of its budget deficit (or current account deficit) by issuing domestic currency debt in international markets rather than issuing foreign currency instruments. 
• Regulating Capital Flows: It results in lowering the impact of sudden stops and reversals of capital flows and enhances the ability to repay external sovereign debt. 
• Reducing requirement of forex reserves: It reduces the requirement to maintain and depend on large foreign exchange reserves in convertible currencies to manage external vulnerabilities. 
  • Presently, India’s foreign exchange reserves are at a record high of $642.63 billion as of March 2022.

Key challenges in the internationalization of currency:

• • Exchange Rate Volatility: May result in a potential increase in volatility of its exchange rate in the initial stages.

• Monetary Policy Dilemma or Triffin Dilemma: It is a conflict that arises when a country needs to supply enough of its currency to meet global demand while also maintaining its domestic monetary policies.

• Vulnerability to External Shock: May accentuate an external shock, given the open channel of the flow of funds in and out of the country and from one currency to another.
• Macroeconomic Stability: Integration of financial markets could affect stability in the long-term.

Approach for internationalization of Rupee 

• Capital Account Convertibility: INR (Indian National Rupee) is fully convertible in the current account but partially in the capital account. 
  • There is need to review extant Foreign Exchange Management Act (FEMA) provisions and extending incentives for international trade settlements in INR. 
  • Banking Services (loans, guarantees, credit lines, etc.) in INR through offshore branches of Indian banks. 
• Promoting international use of INR: To facilitate international financial transactions in INR, an efficient settlement mechanism, availability of liquidity and development of robust cross-border payments system would be required. 
  • Currency Swaps and Local Currency Settlement (LCS): These provide currency diversification that stabilises the local currency, protect businesses against currency risk exposure and reduces transaction costs. 
  • Internalisation of Indian Payment Systems: Extension of global reach of India’s payment systems including Real Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT) and Unified Payments Interface (UPI). 
  • Inclusion of INR in Continuous Linked Settlement (CLS): CLS is a global system for the settlement of foreign currency transactions on a Payment vs Payment (PvP) basis. 
    • CLS system currently settles trades in 18 currencies. However, INR is not among those currencies. 
  • Creation of an Indian Clearing System: Clearing system would provide its member banks with a market to purchase currencies against their domestic currency. 
  • INR as a vehicle currency/contender to Special Drawing Rights (SDR) basket: It can be taken forward by encouraging trade invoicing in INR by expanding trade relations with other economies.

Several steps taken towards the internationalization of the Indian Rupee (INR). 

• • Use of Indian Payment Infrastructure: India has linked its UPI system with Singapore’s PayNow and is expanding UPI’s global reach.
  • Special Vostro Rupee Accounts (SVRAs): The RBI has established a mechanism for INR trade settlement with 22 countries by allowing their banks to open SVRAs.
  • INR as a Designated Foreign Currency in Sri Lanka: This has facilitated INR-based bilateral trade.
  • Asian Clearing Union (ACU): The RBI proposed including INR as a settlement currency in the ACU.
  • Gujarat International Finance Tec-City (GIFT City): It hosts Financial Market Infrastructures (FMIs), including international exchanges and a depository.

• Bilateral Swap Arrangements (BSA):

• • India has a BSA with Japan for up to USD 75 billion as a financial safety net.
  • India recently signed a 35 billion rupees currency swap agreement with the UAE.