The global economy faces challenges due to the pandemic-induced recession and geopolitical tensions, resulting in currency crises in several developing countries. Despite this, India has been on a steady economic course and is making efforts to replace the USD-based settlement system with one based on the Indian rupee (INR), which would benefit both trade partners.
Chief Economic Advisor, V. Anantha Nageswaran, expects the rupee to be less under pressure in 2023, given India's higher GDP growth and the possibility of a weaker USD and cheaper commodity prices. However, India still needs to address its structural challenges to realize the full potential of the rupee as a global currency.
Initiatives towards Internationalization
The Reserve Bank of India (RBI) has taken the first steps towards internationalizing the rupee, starting with business transactions. Traders can now settle transactions in INR, with several countries, including Russia, Sri Lanka, Malaysia, Mauritius, Singapore, Myanmar, Israel, and Germany, agreeing to make payments in INR. These countries open a Vostro account with an Indian bank to make payments in INR.
Benefits of INR as a Global Currency
Internationalizing the rupee reduces India's reliance on foreign exchange reserves, lowers transaction costs and risks associated with currency conversions, boosts India's trade competitiveness and diversity, and enhances its geopolitical and soft power. It also offers an alternative to the USD-dominated international financial system, provides access to India's burgeoning market for partner countries, and helps overcome liquidity limitations and balance-of-payment issues.
Opportunities with Digital Currency
The RBI is developing a digital version of the INR, which could make transactions faster, cheaper, and more secure. India has one of the highest potentials for global central bank digital currency (CBDC) adoption. A CBDC could increase India's GDP by up to 3% by reducing transaction costs and increasing financial access.
Currency's Volatility is a Challenge
One of the main challenges in internationalizing the rupee is its volatility, which has been exacerbated by India's high current account deficit, high inflation rate, dependence on oil imports, and RBI's interventions in the foreign exchange market. India needs to develop its financial infrastructure and institutions to support the smooth functioning of the rupee trade settlement mechanism.
The most prominent obstacle is the currency's volatility, which has hindered its adoption by international investors. The rupee has been one of the worst-performing currencies in Asia, having depreciated by approximately 11% against the US dollar in the last year alone. As of March 29, 2023, the exchange rate was ₹82.32 per USD. This volatility is due to several factors.
Firstly, India's current account deficit, which has been high for many years, creates a demand for foreign currency and puts pressure on the rupee. Secondly, India's high inflation rate has eroded the purchasing power of the rupee, making it less attractive to foreign investors. Thirdly, India's dependence on oil imports exposes the rupee to fluctuations in global oil prices and geopolitical tensions. Finally, the intervention of the Reserve Bank of India (RBI), which aims to stabilize the rupee by buying or selling foreign exchange reserves, can also affect the supply and demand of the currency in the market.