India Must Push Rupee as International Trade Currency; Benefits Far Outweigh Losses
India has a massive trade deficit of more than $150 billion. One of the most effective ways to address this trade deficit is to implement Rupee trade for significant imports. The Rupee trade has been discussed for over a decade, but it has yet to take off, owing to a variety of geopolitical and economic constraints.
Current global trade dynamics necessitate the availability of free currency acceptable to both parties before such transactions are carried out. Also, balancing the strengthening or weakening of a currency requires the fixing of rates, which has an impact on exports and imports.
Since the end of World War II, the dollar has served as the world’s primary reserve currency, and it is the most widely used currency in international trade. By mitigating exchange rate risk, the internationalization of the rupee can lower the transaction costs of cross-border trade and investment operations.
However, the RBI claims that this “makes the simultaneous pursuit of exchange rate stability and a domestically oriented monetary policy more difficult unless supported by large and deep domestic financial markets capable of effectively absorbing external shocks.”
The 1966 devaluation focused attention on the gold clause. India not only discovered that it was now in a sticky legal situation — with the Soviet Union determined to dig in its heels and insist on the application of this clause to contracts between the two countries, and the other countries were waiting to see how this test case would be resolved — but rupee trade between India and eastern Europe came to a halt immediately after the devaluation.
This caused great concern in India because only a quarter of the trade planned for the 1966 calendar year had been completed at the time of the devaluation.
The gold clause defined the agreed-upon value of the rupee in terms of gold so that if the rupee depreciated, the adjustment would take the form of additional payment in rupees. As exercises conducted in response to Russia’s demand for compensation revealed, the benefits of the gold clause worked against the Indian exporter.
While it applied to Russian exports to India, it did not apply to Indian exports to Russia because price contracts did not allow for domestic price increases caused by devaluation.
The 1966 devaluation reinforced India’s resolve to include an asymmetric gold clause in future Rupee payment agreements. This was easier said than done, as the Soviet Union and Poland, in particular, were opposed to any move to protect Indian exporters’ receipts in the event of another rupee devaluation. Disputes over how to solve the problem raged on for several more months, removing some lustre from the bilateral payment agreements.
The devaluation of the sterling in 1967 added to the confusion and uncertainty. Still, it also highlighted the risks of basing bilateral trade on third-country currencies over the parity of which neither of the contracting countries had any control.
Global turnover in foreign exchange markets increased by 33% between 2016 and 2019. But in 2013, turnover in emerging market economy currencies increased by nearly 60%, increasing their global share to 23% from 15%. The Indian Rupee (INR) is among the key drivers, which has nearly doubled in value in comparison to the Mexican Peso (MXN), South African Rand (ZAR), Malaysian Ringgit (MYR), and even Singapore Dollar (SGD).
In terms of average daily turnover, the INR Non-Deliverable Forward (NDF) market is the second-largest in the world, second only to the onshore forward market (BIS, 2019). Volumes in the offshore NDF markets have also increased due to a variety of factors, such as ease of access. Convertibility of Capital Accounts.
The ability to convert domestic currency for capital account transactions is referred to as capital account convertibility. The capital account is made up of cross-border capital movement in the form of investments and loans.
In the last three decades, India has made significant progress in liberalizing capital account transactions, and it now has partial capital account convertibility. Increased foreign portfolio investment limits in Indian debt markets, as well as the introduction of the Fully Accessible Route, are two recent moves. Nevertheless, a more defined policy and liberalization framework is required here.
While China actively pursues a policy of Renminbi internationalization, India appears to be de-internationalizing the Indian rupee (INR). Nepal, one of the two countries that had adopted the INR as legal tender, had to prohibit the use of notes worth more than Rs 100 as legal tender.
Given the demand from people involved in the two countries’ trade and tourism links, Nepal has now requested that the Reserve Bank of India (RBI) allow the use of higher denomination rupee notes in Nepal. The RBI should concur.
Eighty per cent of global trade is conducted in dollars. The dollar, as a currency of trade, a store of value, and a reserve currency for central banks around the world, provides the United States with numerous advantages.
The United States does not have to be concerned about current account deficits. It does not have to be concerned about foreign currency exposure or the impact of exchange rate fluctuations on trade and debt. The US has even threatened to use its international currency power to impose sanctions on countries such as Iran.
Countries such as those in Europe, which have a lot of active trade in the region, recognized the benefits of having a common currency with their trading partners and created the Euro. China has been on the rise since 2010.
China’s currency has been added to the IMF’s Special Drawing Rights (SDR) basket. The renminbi has officially been designated as a reserve currency. Despite China’s capital controls discouraging the use of its currency, the People’s Bank of China is still trying.
The renminbi is used in trade with Vietnam, Myanmar, Laos, Central Asian Republics, and other countries. Its goal is to become a major currency in the region, Asia, and eventually the world.
In contrast, India has yet to recognize the soft power of making the INR an international currency. We were so concerned about the short-term goals of reintroducing a few more rupees through the Nepal route that the RBI refused to exchange old rupee notes with Nepali businesses and households that had been demonetized.
Nonetheless, despite the sense of betrayal and loss of faith caused by demonetization, businesses and households in Nepal are willing to use and hold rupees due to trade and tourism pressures. This is something we should celebrate.
The rupee’s use would reduce foreign currency risk for Indian businesses while also stabilizing trade. Trade-in rupees mean less reliance on the dollar and other foreign currencies. In the past, India experimented with the rupee.
The question for Indian policymakers is whether they want to make the rupee more acceptable globally. Following the 2008 global financial crisis, which demonstrated the fragility of a system reliant on the United States, China has answered the question unequivocally with a resounding yes.
If we say yes and want to make the rupee a global currency, we must begin locally with our neighbours in the long run.
Edited by Prakriti Arora