Internationalising the rupee

the Reserve Bank of India (RBI) released the Report of the Inter-Departmental Group on Internationalization of the Rupee. RBI took pains to ensure that people knew that “(T)he report and its recommendations reflect the views of the IDG and do not in any way reflect the official position of the Reserve Bank of India. The recommendations of the report will be examined for implementation.”

Nonetheless, the report was certainly timely given the ongoing buzz about rupee invoicing with various countries, most notably, of course, Russia. Since the Ukraine invasion and resulting sanctions, many countries have recognised that they need to broaden their range of invoicing and settlement processes to protect against the risk of ever falling afoul of the Big Daddy of international finance. Thus, it was a prudent move to explore the alternatives, amongst which would be “internationalising” the rupee.

The report has recognized that internationalisation is an ongoing process and, though we are still in very early stages, it makes sense to plan for the evolution and the report has highlighted several stages and steps that we could/can take.

The road travelled by the Chinese yuan was studied in some detail, and it was recognised that the major advantages that China has over us is that they have a huge share of world trade and run a sustained trade surplus—thus, companies who buy from China have ready use for yuan to pay for their imports. India’s share of world trade is still minuscule, just about 2% of global exports. Further, and importantly, we run a large trade deficit, although we do have surpluses with some countries, including the US, Bangladesh, Nepal, some EU countries, Turkey and the UK.

Again, even though, like the rupee, the yuan is not fully convertible on the capital account, it has been included in the SDR since October 2016, which means it is already part of most countries’ reserves. Being included in the SDR would represent the end-point of this road to internationalisation, according to the IDG. This requires our exports to grow substantially to where they are of significantly larger value over a five-year period, and our currency should be “(i) widely used to make payments for international transactions, and (ii) is widely traded in the principal exchange markets.” It will clearly take some time for us to get to this level of internationalisation—the report suggests that it would be 5+ years.

In the near term, however, there are several structural changes that are needed and can be implemented relatively easily. The RBI has already been receiving a large number of proposals from various jurisdictions for multilateral/bilateral swaps and trade arrangements in local currencies. We already have a swap agreement in place with Sri Lanka (although under it, Sri Lanka can draw USD or EUR, in addition to INR from the RBI) and a local currency swap arrangement with SAARC. Starting with countries where we have a trade surplus, we need to explore what we need to put in place to enable local currency swap agreements. The primary requirement is that the partner country should have access to rupee liquidity so their companies could pay for Indian exports in the rupee; correspondingly, their exporters would only be willing to invoice their exports in rupees if, in addition to trade, they had other avenues for investing the rupees they earn, such as FDI, FPI, sovereign and corporate debt, infrastructural projects, and interest-bearing deposits. (Incidentally, just this month, Bangladesh launched a trade transaction denominated in INR.)

This will require several plumbing changes—e.g., recalibrating the FPI regime, harmonising KYC requirements, ensuring that exports in INR get the same benefits as exports in other currencies, opening of off-shore INR accounts for non-residents, eliminating the constraints on domestic bonds being included in global indices, etc. All of this would require, in addition to regulatory changes, considerable further strengthening of our financial markets. While this is a continuous work-in-progress, we could implement some changes quite quickly—e.g, shifting to a 24X5 global INR market, allowing all domestic banks (other than only those having ICU branches in Gift City) to access and sell derivatives on non-deliverable forwards; and allowing domestic users to access the FX market without having any underlying exposure, etc. All this would enable a huge jump in INR liquidity both domestically and an increasingly integrated—onshore and offshore—market.

One of India’s big pluses is our highly successful INR-based payments system (RTGS, NEFT and UPI)— we need to expand this to partner countries to enable more cost-effective settlement of INR/FCY transactions, swaps, etc. The RBI has already (in July) initiated a scheme for cross-border remittances with Singapore in either currency using the UPI-PayNow interface.

It seems clear that many of the building blocks are already in place, but we need to move forward in a focused and ordered manner. While the RBI is the primary driver of many of the changes needed, there will, of course, be many areas where the government will have its say, which could slow things down—for instance, eliminating withholding tax on masala bonds (to provide overseas holders of INR with a cost-effective investment alternative), and eliminating gaps between taxation of financial markets in India and in global financial centres.

While all of these (and several more points detailed in the report) may sound like a tall order, most of them are merely extensions of deregulation already on track. The inter-departmental group at RBI has done a great job in not only articulating the issues but also outlining the solutions.

Original article here