India must push rupiah as currency for international trade, benefits far outweigh losses

India has a huge trade deficit of over $150 billion. One of the best ways to counter this trade deficit is to introduce rupee trading for major imports. Rupee trading has been a topic of discussion for over a decade now, but it has never taken off largely due to various geopolitical and economic constraints. The current global dynamics of trade require the availability of free currencies, which is acceptable to both parties before such transactions are executed. In addition, balancing the strengthening or weakening of a currency means fixing rates, which has an impact on exports and imports.

The dollar has been the world’s main reserve currency since the end of World War II and the most widely used currency for international trade. The internationalization of the rupiah can reduce the transaction costs of cross-border trade and investment operations by mitigating exchange rate risk. But this, according to the RBI, “makes the simultaneous pursuit of exchange rate stability and a domestically oriented monetary policy more difficult, unless it is supported by broad and deep national financial markets which could effectively absorb external shocks”.

The lessons of history

In the early 1960s, the rupee was the unit of account in India’s payment agreements with Eastern Europe. Under the so-called gold clause in many of these agreements, the exchange value of the rupee was fixed in terms of gold, thus effectively protecting the rupee holders governed by such agreements from devaluation. The Reserve Bank was not in the picture when these agreements were made, and when little thought seems to have been given to the importance of this clause.

The 1966 devaluation shines the spotlight on the gold clause. Not only did India discover it was now on a sticky legal wicket – with the Soviet Union determined to dig in its heels and insist on applying this clause to contracts between the two countries and other countries waiting to see how this test case would be solved – Rupee trade between India and Eastern Europe virtually stopped immediately after the devaluation. This caused great concern in India because, at the time of the devaluation, only a quarter of the exchanges planned for the calendar year 1966 had been carried out.

Under the gold-clause, the agreed value of the rupee was defined in terms of gold, so that in the event of a devaluation of the rupee, the adjustment would take the form of an additional payment in rupees. As the exercises undertaken in the wake of the Russian compensation claim revealed, the benefits of the gold clause worked to the detriment of the Indian exporter. While it applied to Russian exports to India, no similar protection was offered to an Indian exporter exporting to Russia, since the price contracts did not allow domestic price increases resulting from a devaluation .

The experience of the 1966 devaluation reinforced India’s determination to incorporate a symmetric gold clause in future rupee payment agreements. This was easier said than done, with the Soviet Union and Poland, in particular, opposing any attempt to protect Indian exporters’ earnings in the event of a further devaluation of the rupee. Disputes over how to resolve the issue continued for several months and tarnished bilateral payment agreements. The devaluation of the pound sterling in 1967 added more confusion and uncertainty, but also highlighted the dangers of basing bilateral trade on third country currencies over the parity of which none of the contracting countries had any control. .

Between 2016 and 2019, global turnover in foreign exchange markets increased by 33%, but turnover in currencies from emerging market economies increased by almost 60%, bringing their global share to 23% , against 15% in 2013. Among the main ones is the Indian rupee (INR) whose exchanges have almost doubled, unlike the Mexican peso (MXN), the South African rand (ZAR), the Malaysian ringgit (MYR) and even the Singapore dollar (SGD). The INR Non-Deliverable Forward (NDF) market is the second largest in the world by average daily turnover and is larger than the onshore futures market (BIS, 2019). Volumes in offshore NDF markets have also increased due to various factors, such as ease of access, market making by global banks, availability of large participants like hedge funds, intermediation services like prime brokerage, favorable tax treatment, time zone convenience and electronicization.

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Capital account convertibility

Capital account convertibility is the ability or freedom to convert national currency for capital account transactions. The capital account consists of cross-border movements of capital in the form of investments and loans. India has come a long way in liberalizing capital account transactions over the past three decades and currently has partial capital account convertibility. Some of the recent measures include raising foreign portfolio investment limits in Indian debt markets and introducing the fully accessible route. However, a more defined policy and liberalization framework is needed here.

Benefits of Currency Internationalization

Firstinternationalization gives the country’s exporters the opportunity to limit the exchange risk, and this benefit can be significant in the case of goods for which payment is made long after the order is placed.

Secondit allows domestic businesses and financial institutions to access international financial markets without incurring currency risk and to borrow at cheaper rates and on a larger scale than they can at home.

Key Aspects of Currency Internationalization

A national currency can be considered an international currency if most of the following conditions (listed by American economist Peter B. Kenen) are met:

1. Firstthe government must remove all restrictions on the freedom of any entity, domestic or foreign, to buy or sell its country’s currency, whether locally or on a futures market.

2. Seconddomestic companies are able to invoice some, if not all, of their exports in their country’s currency, and foreign companies are also able to invoice their exports in that country’s currency, whether to the country itself or to third countries.

3. Thirdforeign companies, financial institutions, official institutions and individuals may hold the country’s currency and financial instruments denominated therein, in such amounts as they deem useful and prudent.

4. Fourth, foreign companies and financial institutions, including official institutions, can issue negotiable instruments in the country’s currency. It can be both equity and debt instruments, not only in the domestic markets of the country, but also in foreign markets, including, of course, the markets of the countries of foreign companies.

5. Fifthfinancial institutions and non-financial companies of the issuing country may issue instruments denominated in the currency of their country on foreign markets.

6. Sixthinternational financial institutions, such as the World Bank and regional development banks, can issue debt securities in a country’s market and use its currency in their financial operations.

Advantages and Disadvantages of Rupee Trading

The disadvantages are:

1. Currently we have to rely on a third currency to benchmark rates at contract expiration
2. Work with other global federal banks to define a working model
3. Standard policies and operating model of the RBI for undertaking rupee trading and also controlling the local effects of external shocks

Advantages are :

1. Likely reduction in the trade deficit of around $20 billion on a monthly basis
2. Other countries are adopting rupiah as currency for their business activity
3. Strengthening of the rupee in the global market
4. The Rupee becomes a reserve currency over a period of time for developing economies for trading purposes

The Benefits of Rupee Trading Outweigh the Losses

Aggressive international trade lobbying is needed to actively promote rupee trade with mainstream economies. On the other hand, we need to keep a close watch on Indian exports. There are two dangers we need to watch out for: first, the diversion of Indian exports from the international market to other countries; and second, re-exports from third countries through the rupee payment channel.

With the outlook in Delhi dominated by the country’s balance of payments problems, the benefit of paying for imports of capital goods in inconvertible rupees was thought to outweigh these losses. The overall benefit of rupee trading outweighs the long-term negative factors. Also, to become a player in world trade, the local currency should be the privileged instrument of negotiation.

The author is a world expert in international trade policies and technology transfers. The opinions expressed in this article are those of the author and do not represent the position of this publication.

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