• UGI USER
  • Oct 29, 2022
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Internationalization of the rupee has risks but they are unavoidable

Why in News?

A deputy governor of the Reserve Bank of India (RBI) recently emphasized the advantages and risks of the internationalization of the rupee.

 

What is the Internationalisation of the Rupee?

● Internationalization of the rupee is a process that involves increasing the use of the local currency in cross-border transactions.
● It involves promoting the rupee for import and export trade and then other current account transactions followed by its use in capital account transactions.
○ As far as the rupee is concerned, it is fully convertible in the current account, but partially in the capital account.
○ Current and Capital accounts are the two components of the Balance of payments. While the current account deals mainly with the import and export of goods and services, the capital account is made up of the cross-border movement of capital by way of investments and loans.

 

Why is the Need for the Internationalisation of the Rupee?

● The dollar accounts for 88.3% of global foreign exchange market turnover, followed by the euro, Japanese Yen, and Pound Sterling; the rupee accounts for a mere 1.7%, underlining the need for pushing the currency much further to get an international tag.
● In the case of the dollar, which is an international currency, the ‘exorbitant’ privileges include immunity from the Balance of Payments crises as the USA can pay for its external deficits with its own currency.

 

What are the Various Advantages of the Internationalisation of the Rupee?

● The use of the Rupee in cross-border transactions mitigates currency risk for Indian businesses. Protection from currency volatility not only reduces the cost of doing business, it also enables better growth of the business, improving the chances for Indian businesses to grow globally.
● 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.
● Reducing dependence on foreign currency makes India less vulnerable to external shocks. For example, during phases of monetary tightening in US and the strengthening dollar, excessive foreign currency liabilities of domestic business results in a de facto domestic tightening. Reduced exposure to currency risk would substantially mitigate the pain of the reversal of capital flows.
● As the use of the Rupee becomes significant, the bargaining power of Indian businesses would improve adding weight to the Indian economy, and enhancing India’s global stature and respect.

 

What are the Challenges in the Internationalisation of the Rupee?

● 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.
● 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 Rupees could exacerbate the 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.

 

What are the Steps taken for the Internationalisation of the Rupee?

● In July 2022 the RBI introduced a mechanism to facilitate international trade in rupees.
● Enabling external commercial borrowings in Rupees (especially Masala Bonds).
● 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 favored by all countries, and therefore, is worth exploring.

 

Way Forward

● The recent initiative of invoicing trade in the rupee comes from a different global requirement and order, but for true internationalization and wider use of the rupee overseas, opening up of trade settlement in the rupee alone will not suffice. Further opening up and liberalizing settlements in the rupee for various financial instruments both in India and overseas markets are more important.
● Rupee internationalization may also require an efficient swap market and a strong foreign exchange market.
● Further improvement in overall economic fundamentals, and financial sector health, followed by an upward movement in sovereign ratings will also strengthen confidence in the rupee, making the currency ready for the next step in its international journey.

 

UPSC Civil Services Examination Previous Year Question

Q. Convertibility of the rupee implies (2015)

(a) being able to convert rupee notes into gold

(b) allowing the value of the rupee to be fixed by market forces

(c) freely permitting the conversion of the rupee to other currencies and vice versa

(d) developing an international market for currencies in India

Ans: (c)

Q. With reference to the Balance of Payments, which of the following constitutes/constitutes the Current Account? (2014)

1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Rights

Select the correct answer using the code given below:

(a) 1 only

(b) 2 and 3

(c) 1 and 3

(d) 1, 2 and 4

Ans: (c)