Reserve Bank of India Deputy Governor T Rabi Sankar has said internationalisation of the rupee is a desirable objective of public policy because usage of Rupee in cross-border transactions mitigates currency risk for Indian business and also reduces the need for holding foreign exchange reserves.
The Deputy Governor said protection from currency volatility not only reduces cost of doing business, it also enables better growth of business, improving the chances for Indian business to grow globally.
On the issue of holding foreign exchange reserves, he said while reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy. For example, there is a general agreement that India’s reserves are borrowed funds. He said banks and corporates incur external debt at market rates which are then invested in government securities issued by advanced economies (AEs).
The deputy governor said reducing dependence on foreign currency makes India less vulnerable to external shocks. For example, during phases of monetary tightening in US and strengthening dollar, he said excessive foreign currency liabilities of domestic business results in a de facto domestic tightening. The ‘Taper Tantrum’ episode in 2013 and the currency volatility experienced by most emerging market economies (EMEs) in recent months exemplify such risks. Reduced exposure to currency risk would substantially mitigate the pain of reversal of capital flows, he said.
As the use of Rupee becomes significant, he said the bargaining power of Indian business would improve, adding weight to the Indian economy, and enhancing India’s global stature and respect.
On the steps taken by the central bank, he said enabling external commercial borrowings in rupees (especially masala bonds) was one step. Though invoicing export and import in rupees was long permitted, it was being resorted to for limited uses. The July 2022 scheme of RBI permitting rupee settlement of external trade created a more comprehensive framework, including the flexibility of investing surplus rupees in Indian bond markets, he said.
He said, “We are receiving encouraging response from countries to participate in Rupee-based trading. The Asian Clearing Union is also exploring a scheme of using domestic currencies for settlement.” An arrangement, bilateral or among trading blocs, which offers importers of each country the choice to pay in domestic currency is likely to be favoured by all countries, and therefore, is worth exploring, he added.
As increased use of Rupee in cross-border transactions requires a unified global market in the local currency both in interest rates and currencies, he said such unification would not only improve depth and liquidity of our markets, but they would also facilitate uniform pricing across borders.
Accordingly, he said the central bank had also been putting in place enabling conditions by way of linking the domestic rupee interest rates and currency markets with offshore rupee markets by enabling domestic banks to operate in the offshore markets.
In terms of risk, he said India is a capital-deficient country, and hence needs foreign capital to fund its growth. If a substantial portion of its trade is in rupee, non-residents would hold rupee balances in India which would be used to acquire Indian assets. The deputy governor said large holdings of such financial assets could heighten vulnerability to external shocks, managing which would necessitate more effective policy tools.
A reduced role for convertible currencies in external transactions could lead to reduced reserve accretion, he said, adding that at the same time, however, the need for reserves would also reduce to the extent the trade deficit is funded in the local currency.