A study by India’s central bank, RBI, has mooted the idea of floating the rupee as a global currency, but asked the government to carefully assess the pros and cons of such action, as it may increase volatility in forex markets.
The idea was mooted after the global financial crisis and weakening of the U.S. dollar triggered a debate about an alternative global currency.
The study titled, “Internationalisation of Currency: The case of the Indian Rupee and the Chinese Renminbi”, also said it is quite unlikely that the dollar will lose its predominance as the global reserve currency in the foreseeable future.
“The current crisis has, however, thrown open the debate on the need for a new global reserve currency in case the U.S. economy fails to make a significant turnaround and the weakness of the U.S. dollar persists,” it added.
The recommendations were made in a study, authored by RBI Director Rajiv Ranjan and Assistant Advisor Anand Prakash, which said that among emerging market currencies, the yuan and the rupee are natural contenders for international currency status.
However, while China is “far from ready” to achieve global reserve currency status at the moment, India needs to meet “all the necessary preconditions...before (it) could proceed further,” it said.
“There are, however, problems associated with internationalisation of the rupee as it could increase volatility of its exchange rate,” the study said.
Outlining the difficulty in positioning the Indian currency as a global reserve, the study said that unlike China, which has a large current account surplus, India has a significant trade and current account deficit.
Current account balance broadly relates to exports and imports of goods and services and investment income from global trade.
Withdrawal of short-term funds and portfolio investments by non-residents could also be a major potential risk of internationalisation of the Indian rupee, it added.
“The Indian rupee is rarely being used for invoicing of international trade,” the study pointed out.
It further noted that the strength exhibited by the Indian rupee in recent months and continued good performance of the Indian economy have raised the issue of greater internationalisation of the Indian rupee and India needs to proactively take steps to increase the role of the domestic currency in the region.
Internationalisation of rupee would also require India to make the rupee fully convertible. This means that rupee could be exchanged against other currencies freely. There are currently curbs on such convertibility, so far as capital accounts like stocks are concerned.
The study said, “India has so far followed a calibrated approach towards capital account liberalisation. India, at present, does not permit the rupee to be officially used for international transactions, except those with Nepal and Bhutan, though there are indications of the Indian rupee gaining acceptability in other countries.”