War on dollar

Is announcing internationalisation of the Indian rupee a reactive response?
Representational Image
Representational ImageFile/ GK

Even as the US dollar is giving heavy beating to the Indian rupee in the currency market and has pushed it to record low of Rs.79.61 (value recorded on Tuesday morning), the Reserve Bank of India has triggered a war against the US currency by announcing measures to internationalize the Indian rupee.

In a way, the Indian regulator has put its much demanded arsenal into action to combat the dollar’ forward movement, at least, in its own markets and bring the rupee to a respectable level.

The RBI on Monday asked banks to put in place additional arrangements for export and import transactions in Indian rupees in view of increasing interest of the global trading community in the domestic currency.

Banks will however require prior approval from the Foreign Exchange Department of the Reserve Bank of India (RBI), the apex bank said in a circular.

The war on US dollar has been announced at a time when the fall in the value of rupee is prolonging and all measures to arrest its devaluation have proved ineffective.

Continuing flight of foreign institutional investors (FIIs) from the Indian markets, widening trade deficit, dwindling foreign exchange reserves and higher global energy prices are the major factors responsible for pushing the rupee to a new record low almost every day.

If the currency experts are to be believed, the rupee is due to fall over Rs.80 against the dollar in the current week. On the international trade front, the Government data reveals that for the first quarter of the current financial year, the trade deficit has widened to $70.25 billion due to high imports.

The country’s forex reserves have fallen by more than Rs 1 trillion since the outbreak of the Russia-Ukraine war in February.

Analysis of the data further suggests that India could convert 16.38% of its total trade from US dollars into rupees if its neighbours (Pakistan not included)) and Russia.

Notably, inflation has already overshadowed the growth path and a Reuters poll pencil India’s inflation to hold above the top of the RBI’s tolerance band for at least the rest of 2022, longer than previously thought, making several more interest rate hikes in coming months all but inevitable.

A top Asian economist, Miguel Chanco, has warned that inflation in India will prove a lot more stubborn than it will in other parts of Asia. Rising global commodity prices to unprecedented levels in the past one year have directly impacted the price regime of essential and non-essential commodities.

Resultantly, the inflation breached the RBI’s 6% upper tolerance level and continues to soar. This has pushed the cost of living in the country to all time high and most of the 1.4 billion population is reported to be struggling to keep their household budgets afloat in the pandemic of soaring prices. A solid fiscal response to neutralize the rising cost of living is still awaited.

So, after the inflation woes, a weakening rupee, which is already down over 6% for the year, has exacerbated the issue further for the common man. Meanwhile, the RBI’s move to push the rupee in international trade for settlement of payments is not something that has happened in a jiffy.

In fact, the apex bank had been deliberating upon internationalization of the rupee in the past too, especially on the occasion whenever rupee used to slip against dollar.

It’s interesting to note that the Indian rupee until mid-1959 was being used as means of payments in countries like Kuwait, Malaysia, United Arab Emirates (UAE) and Qatar. Even Gulf rupees were used outside India in the Gulf countries until 1966. This arrangement ended in the mid-sixties.

Later, over two decades back, the RBI commissioned two studies in 2010 (Internationalisation of Currency : The case of the Indian Rupee and Chinese Renminbi by Rajiv Ranjan and Anand Prakash) and 2011 (An internationalized rupee? by Shyamala Gopinath) to examine the issues surrounding the internationalization of the rupee.

Interestingly, both the studies had rightly recommended internationalization of the rupee to start with increasing the role of the Indian rupee in its local region where China’s currency, Renminbi (also known as Yuan) has taken a lead over it.

Notably, China is using its currency for trade with Vietnam, Myanmar, Laos, Central Asian Republics etc. Use of Renminbi across local geographies is an effort by China to make its currency popular in Asia and then globally. It’s in this context India was prompted to explore the possibility of internationalizing the rupee and formally allowed the two studies mentioned above.

Last year in February, the steep fall in the value of rupee against the dollar again turned the heads in the apex bank towards the possibility of internationalization of the rupee. The RBI came out with its report on currency and foreign exchange which stated that internationalization of the rupee was “inevitable”.

However, the report added that ‘the most important prerequisite for internationalization of a currency is price stability.’ In the inflationary scenario, which has already breached the RBI’s tolerance level, the report “undermines the use of the currency as an international medium of exchange and a store of value and can “restrict the role of such an economy in global value chains”.

Now, let’s come to the RBI directive on the use of rupee in international trade. The move has placed the most important question on the supremacy of the dollar.

Will internationalization of rupee impact dominance of the US dollar? At the moment, it would be immature to comment in response to the question. At present, eighty per cent of the world’s trade is done in dollars.

In other words, the dollar is undisputedly the currency of global trade and serves as a store of value and central bank reserves all over the world. Dislodging the might of the dollar is not an easy task. You need a stable economic power to take head-on with this most powerful currency of the world.

China accelerated its measures to internationalize its currency - Renminbi - soon after the global financial crisis of 2008, but has not been able to prove a cause of concern for dollar dominance in global trade.

Despite doing everything in its power for years to reduce dependence on the dollar and assert its influence on trade and finance, China went to great extent to increase the international use of its currency, the Renminbi.

But it couldn’t succeed in tagging its currency as global significance.

We need to take a cue from the situation and primarily focus on promoting the use of the rupee as a means of payment settlements in trade with neighboring countries.

Once acceptance of the rupee holds ground in the region around us, it can, in the long run, reduce the influence of the dollar.

There would possibly emerge never-seen-before challenges, which demands extraordinary caution from the regulator and should always be ready to handle any kind of situation while making the rupee an international currency.

(The views are of the author & not the institution he works for)

Disclaimer: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.

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