Is the Indian rupee ripe enough to be an international currency?

Today if you travel abroad and look up the list of currencies with any money changer, you would find most of the hard currencies like the Dollar, Euro, Pound, Yen, Australian Dollar, Canadian Dollar, Singapore Dollar etc. However, despite being among the top 5 countries in terms of GDP, India does not figure in the list of most money changers abroad. The reason is that the Indian rupee is not yet an international currency; means it is not fully convertible on the capital and current account. In other words, Indian rupee is still not a freely market determined currency but there is a lot of regulator influence.

In the past, Indian government has been cautious about making the rupee convertible as it could lead to a run on the currency. There were plan for full convertibility laid out in the 1997 Union Budget by P Chidambaram. However, just a few months later, the Asian currency crisis struck and India has since given up the idea of making the Indian rupee a fully convertible currency. However, now experts are veering around to the view that the time may have finally arrived. In a recent interaction with FEDAI members, RBI deputy governor Rabi Shankar, again posed the question; if it was time to shift gears on the rupee?

In a sense, Indian economy has come a long way in the last 30 years since liberalization. Total merchandise trade of over $1 trillion a year, robust services trade, record FDI flows and currency reserves among the top-5 has created confidence in the central bank. It has sent a feeler that is, perhaps, time to make rupee an international currency. Here is why.

Is India ready for an international rupee?

To answer this question, we need to look at two data sets, we will first look at the merchandise trade data and follow it up looking at the FDI / FPI flows data. Let us look at the trade data first.

Data Source: Ministry of Commerce (FY23 data is annualized)

The above data captures the total trade over the last 10 fiscal actuals and the trade for FY23 is extrapolated based on 6-months data. India’s share in total world trade is still in the region of around 3%, which his not too high if you look at the other major trading nations like the US, China and Germany. However, the trade volumes have grown substantially in the last few years, with the total trade crossing 1 trillion in FY22 and likely to cross Rs1.20 trillion in FY23. Let us now turn to the FPI and FDI flows into India.

Data Source: RBI

While foreign portfolio flows (FPI) have been volatile over the last 10 years, the foreign direct investments (FDI) has been showing a steady growth over the last decade. One concern over making the Indian rupee a freely convertible international currency is that it may encourage more Indian money to go abroad.

Why rupee as international currency is still desirable?

The crux of the argument put forth by Rabi Shankar in the address to FEDAI is that, despite some concerns over outflows and currency attacks, it is still a good idea to move the rupee towards becoming an international currency. Making the currency convertible is the first step to improve the overall standard living of India. It is said that if a currency is freely convertible, then it can be used for cross border transactions and that gives privileges.

However, a currency does not become an international currency overnight and it is a long-haul job for many years. So, it is about moving towards rupee denominated trade; not only with Iran, Sri Lanka and Russia but also with other emerging market currencies. Also, if the currency is international, the need to hold reserves is limited. UK and most of Western Europe hardly carry too much of reserves in foreign currency.

Here are few reasons why the process of internationalization of rupee has to start.

·         Today, oil imports and ECB borrowings are a major source of currency risks, since these repayments have to be done in dollars. If the rupee becomes an international currency, then the payments can be made in rupee. This not only protects the Indian economy from currency market volatility but also encourages rupee demand in the global currency markets.

·         If the Indian rupee becomes freely convertible, the need to hold huge forex reserves comes down. Currency, there is a lot of panic in forex markets as the RBI reserves have come down from $647 billion to $528 billion as the RBI has sold spot dollars to prop up the rupee. For instance, holding currency reserves in dollars entails a cost equal to the interest rate differential. That gap is 3% today, so on forex reserves of $600 billion, India incurs average annual cost of $18 billion.

·         Indian rupee has seen a lot of pressure due to dependence on forex reserves. A lot of that money can flow out at short notice. This will ensure that the currency does not become too vulnerable if there is any foreign shock like sub-price or the crisis in Credit Suisse. That is something that is not oft spoken about.
 
Are there downside risks to making rupee an international currency?

One of the arguments in favour of going slow on rupee convertibility is that India is a capital deficient country and needs foreign capital to fund its growth. Substantial rupee trade would mean a lot of rupee holdings by other central banks, making the rupee fairly volatile and vulnerable to sudden movements. Secondly, the NRIs are major suppliers of foreign flows into India and it stood at $87 billion in the latest year. If all this is held in rupees, it creates a liquidity glut for the Indian market.

However, despite these risks, the process of making the rupee an international currency has to start. It is likely to evolve over time, but the time to start is now. That would ensure that India does not have to live in constant fear that its depleting forex reserves would results in a sovereign downgrade. But, for that to happen, the process must start now.