RBI Should Internationalise Indian Rupee, Says SBI

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What has happened?

The State Bank of India (SBI) on Thursday said the Reserve Bank of India (RBI) should internationalise the Indian rupee.
In a research report, the SBI said that the central bank should make a conscious effort to internationalise the rupee.

“The Russia-Ukraine war and the disruptions to payments caused by it, is a good opportunity to insist on export settlement in rupee, beginning with some of the smaller export partners,” the SBI said.
The banking major also welcomed the RBI’s measures relaxing the external commercial borrowing (ECB) and foreign portfolio investors (FPI) norms in the debt segment.

According to the SBI, the global economy is volatile and on an average, energy, base metals, precious metals, and agricultural prices are now down 25% from 52 week highs,
With markets anticipating a global slowdown morphing into a full-blown global recession.
However, it is not clear whether such decline is the result of synchronised global rate actions or genuine fears of a recession looming large, the SBI report noted.

Rupee will be an international currency if non-residents are willing and able to trade in it and invest in rupee-denominated assets.
For example, a Russian importer must be able (and willing) to invoice and pay for her imports from South Africa in rupees.
Similarly, a UK resident must be able (and willing) to invest her savings in rupee-denominated bonds or shares.
In these cases, non-residents take risks in the rupee as a currency.
The willingness and ability to transact and invest in a currency depend on three prerequisites.

First, the issuing country must have sufficient scale, both in terms of nominal gross domestic product and volume of international transactions.
For instance, while China is a $10.36 trillion economy, India is roughly at $2 trillion.
For India to attain sufficient scale, the economy needs to grow at a sustainable average rate of 7-8% for the next five years or so.
India’s current share of global trade is also relatively small and the bulk of it is invoiced in US dollars.
Improvements in scale are linked to macroeconomic fundamentals, which cannot be changed through an internationalization-driven agenda.

Second, the value of the currency must be stable over time.
A currency is considered stable when the general level of prices does not vary too much.
Stability has multiple aspects: macroeconomic, financial and political.
On macroeconomic stability, India undertook an important reform in the form of the Monetary Policy Framework Agreement that formally lays down inflation targeting as the objective of monetary policy in India.
Not much progress, however, has been made on financial stability.
The banking system continues to be overburdened with burgeoning non-performing assets.
Improving financial stability will need urgent reform of the banking system and strengthening banking regulation.
In terms of political stability, the fact that India is a democracy, like issuers of most international currencies in the 19^thand 20th centuries, goes in its favour.
Democracy and associated checks and balances on the executive, instil confidence in foreign investors about the policy credibility of the government, thereby imparting stability to the national currency.

Third, the currency must be liquid.
A currency is liquid if significant quantities of assets can be bought and sold in the currency, without noticeably affecting its price.
This requires depth in financial markets, a large stock of domestic currency-denominated bonds and adequate options to hedge currency risk exposures.
India lacks a deep, liquid and well-functioning corporate bond market.
Hedging opportunities for foreign investors are limited.
There are entry barriers on who can offer and trade in currency derivative products, and on what conditions.
Extensive regulatory reform is required to create a deep market that will offer foreign investors suitable hedging options.
A large base of foreign investors adds to the liquidity in the domestic market.
India has one of the least open capital accounts among emerging economies.
Relaxing capital controls to attract foreign investor participation is crucial for enhancing rupee liquidity.

First, internationalisation gives the country’s exporters an opportunity to limit exchange rate risk, and this benefit may be significant in the case of goods for which payment is made long after they are ordered.
Second, it permits domestic firms and financial institutions to access international financial markets without incurring exchange rate risk and borrow at cheaper rates and on a larger scale than they can at home.

To conclude, any conversation on rupee internationalization dehors structural reforms is futile.
Scale, stability and liquidity can be achieved through strong economic fundamentals and a process-driven regulatory environment.
These, by themselves, are important policy goals to achieve for India.
It is possible that once these are achieved, the rupee will come to be accepted as an international currency.

Q) Which country became the first to officially adopt a gold standard for currency?