On July 11, the Reserve Bank of India created a stir in the financial markets. Its press release titled ‘International Trade Settlement in Indian Rupees (INR)’ permitted Indian banks and the international trade community to invoice and settle transactions in Indian rupee. The policy is quite significant, and is a major step towards internationalisation of the INR.
What is internationalisation of a currency? It means that the currency is accepted across the world as a medium of exchange. The US Dollar (USD) is a currency which has remained international for more than a century now. In early 20th century, the USD replaced the Great Britain Pound (GBP) as the dominant international currency. Post- World War II, this position was cemented further as all currencies were pegged against the USD. Even after the breakdown of Bretton Woods in 1971, the USD has maintained its pole position.
The dominance of the USD caused many an irritation in global politics. In most transactions across the world, the USD is usually the de facto currency of payment which ensures that Washington always plays a crucial role in world affairs. French Minister of Finance Valéry Giscard d'Estaing termed this as “exorbitant privilege”. European leaders gave up their own currency and joined hands to establish the Euro, mainly to counter USD’s hegemony.
Typically, the rise of an economy at the global stage leads to rise in the share of its currency in global transactions. But this has not been the case with the US. Over the last five decades, the share of the US economy globally declined from 25 percent to 15 percent. The USD’s share in foreign exchange reserves and international debt also declined, but at 60 percent it still remains dominant.
The US’ economic decline has coincided with China’s rise. China’s share in global output has risen from 2 percent in the 1980s to 20 percent, which is higher than that of the US. Yet the share of the Chinese Renminbi in the global forex reserves remains a paltry 2 percent while share of Euro has remained stagnant at 18-20 percent since its inception.
Gita Gopinath, First Deputy Managing Director, IMF, along with other researchers has termed this dollar hegemony as ‘Dominant Currency Paradigm’, which poses macroeconomic risks. Mike Carney, former Governor of the Bank of England, argued that in a multipolar world, we need to have multi-polar currencies. He even advocated digital currencies to counter the supremacy of the USD.
Where does the RBI’s July 11 press release fit in this world order of international currencies? The global share of India’s economy has increased from 2 percent in 1980 to around 7 percent currently. It has also become a popular destination for global portfolio flows, and foreign direct investment. The potential growth of the Indian economy pegged at 6-7 percent, much higher than most other countries. The government and the RBI have also opened both current and capital accounts, allowing foreigners to own Indian assets and Indians to buy foreign assets. So there is clearly potential for the growing internationalisation of the Indian economy.
The July 11 note is another major step in this direction of internationalising the economy. The RBI press release notes that “in order to promote growth of global trade with emphasis on exports from India and to support the increasing interest of global trading community in INR, it has been decided to put in place an additional arrangement for invoicing, payment, and settlement of exports / imports in INR.” This implies that hereon, exporters and importers have a choice to invoice their transactions in the INR, which was mainly in the USD till now. The RBI has also permitted banks to tender advance loans to exporters against invoices in the INR.
The policy will also help position the INR as an international currency. Shyamala Gopinath, former Deputy Governor of RBI, in a 2009 speech pointed to three factors for currency internationalisation. First, payments for international transactions can be made in that currency. Second, both residents and non-residents can hold financial assets/liabilities denominated in the issuing currency. Third, freedom for non-residents to hold currency balances, even beyond the territory of the issuing country. The current policy is a step towards the first factor. The RBI and the government have been working on the second and third factors as part of capital account management.
The above policy does not imply that we will see an immediate transition from the USD-based invoicing to an INR-based invoicing. It will at best be slow and gradual. Indian policymakers can start in a small way by encouraging the INR payments with neighbouring South Asian countries and other trade partners. Currently, most South Asian countries are facing a crisis, and requesting India for financial and humanitarian support. Giving aid in the INR and encouraging future invoicing in it will also be a winning preposition for these crisis economies, as they will not require the USD for payments. Having said that, few South Asian economies such as Sri Lanka and Nepal do use INR for payments. The new arrangement should also help India pay Russia for the oil which has been debarred from USD payments.
While the USD has remained a dominant currency, there is early research that economies are moving away from it to other currencies, mainly Chinese Renminbi. The INR could be part of forex reserves too. Isteatndia also has an edge over China in terms of a more open capital account and liberalised financial markets, which should help strengthen the status of the INR.
The international monetary order usually follows the international political order, with a lag. This time around, the duration of the lag has been high, as despite the decline of the US economy, the USD remains dominant. While the USD will still remain dominant in near future, it is fair to expect that its share will gradually decline. The question is which currency will dominate the world monetary order?