Context: Banks from 18 countries have been permitted by the RBI to open special vostro rupee accounts (SVRAs) for settling payments in Indian rupees, the government told the Rajya Sabha recently.
Internationalization of Rupee Background
- RBI’s mechanism for trade settlement in rupees: In July 2022, the RBI had unveiled a mechanism to settle international transactions in rupee.
- The move is aimed to promote the growth of global trade, with emphasis on exports from India, as well as pushing rupee as an international currency.
- The central bank’s move has come in the wake of increasing pressure on the Indian currency in the wake of Russia’s invasion of Ukraine and sanctions by the US and the EU.
- Under the mechanism, all exports and imports may be denominated and invoiced in rupees, with the exchange rate to be market determined.
- Under this, authorized Indian banks have to open Special Rupee Vostro Accounts of correspondent banks of the partner trading country.
What is International Currency?
- The Tarapore Committee on Fuller Capital Account Convertibility (CFAC) defined international currency as ‘a currency that is widely used for international transactions.
- An international currency is supposed to perform three international functions (see image).
- E.g., today, the US dollar is the most widely accepted currency for international transactions, followed by Euro.
- In the early 1960s, even rupee was accepted as legal tender in Qatar, UAE, Kuwait, Bahrain, Oman and Malaysia. But, today, almost 86% of India’s imports as well as 86% of the exports are invoiced in dollars.
What is Internationalization of Rupee?
- Internationalization of a currency (rupee here) is a process to increase rupee acceptance (credibility) across the world through activities such as:
- Increased use for invoicing and settlement of cross-border transactions
- Freedom for non-residents to hold financial assets/liabilities in rupee
- Freedom for non-residents to tradable balances in rupee at offshore locations.
- It can also be referred to adopting full capital account convertibility, i.e., freedom to convert local financial assets into foreign financial assets and vice versa.
- Currently, India allows partial Capital Account Convertibility and full current account convertibility.
Benefits of Internationalization of Rupee
- Reduced Exchange Rate Volatility: If the rupee becomes more widely used internationally, it could potentially reduce the exchange rate volatility, making it more stable and predictable.
- Reduced Vulnerability to External Shocks: because of reduced dependence on foreign currency.
- Enhanced International Trade: Internationalization of the rupee can lead to greater acceptance of the currency, which would make international trade easier and more efficient for Indian businesses.
- Improved current account deficit: because of reduced trade costs and deficits.
- Enhance India’s global stature and respect: It will help Indian Businesses through increased bargaining power. E.g., Post-2008 recession, Chinese efforts to internationalize Renminbi helped in increasing its global stature.
Challenges in Internationalization of Rupee
- Complicates Domestic Monetary Policy: The internationalization of the rupee could limit the effectiveness and independence of the RBI in controlling domestic money supply.
- Increased Refinancing Risk: It could aggravate the pass-through risks of external stimulus to domestic financial markets from non-resident holdings of the rupee.
- During a global recession, for example, non-residents could convert their rupee holdings and move out, increasing refinancing risk.
- Heightened Exchange Rate Volatility: The value of the rupee could become more volatile, particularly if the inflation rate is higher than the global rate or from uncontrolled flow of capital.
- Increased Responsibility to Maintain International Financial and Monetary System Order: This puts an increased burden to play the role of “Lender of Last Resort” in case of any global financial crisis.