Internationalization of the Rupee
The Indian government and financial institutions aspire for the rupee to reach reserve currency status like the dollar, euro, pound sterling, and renminbi (RMB). Recent steps by the Reserve Bank of India (RBI) aim to gradually position the rupee on the global stage, considering both opportunities and risks.
RBI's Recent Measures
- Allowing Indian banks to offer rupee-denominated loans to neighboring countries such as Nepal, Bhutan, and Sri Lanka for trade settlements.
- Expanding special rupee vostro accounts (SRVAs) to enable foreign partners to invest their rupee holdings in Indian corporate debt.
- Setting transparent reference rates for the currencies of India's major trading partners.
This initiative seeks to reduce India's dependency on the dollar, lower transaction costs for exporters, and enhance the confidence in the rupee as a settlement and investment currency, aligning with India's aspirations for increased global economic influence.
Risks and Challenges
An international reserve currency requires significant convertibility on the capital account, enabling free exchange of the domestic currency into foreign currencies. However, this poses risks, including potential capital flight during adverse events, which can deplete forex reserves and destabilize the rupee.
Lessons from Historical Examples
China's attempt to internationalize the RMB in the 2010s serves as a cautionary tale. Despite substantial forex reserves and a strong economy, China faced significant capital flight and a sharp depreciation of the RMB, forcing the re-imposition of capital controls.
Similarly, post-WWII Britain encountered severe challenges in liberalizing its capital account, including the 1947 sterling crisis and the Suez Crisis of 1956, which highlighted the vulnerabilities of sudden capital movements. It took Britain over three decades to achieve full convertibility on the capital account by 1979.
Conclusion
For India, with its comparatively shallow capital markets and smaller forex reserves, the risks of rapid liberalization are significant. Incremental steps, like those recently taken by the RBI, are appropriate, but full convertibility should not be a near-term goal.
