Internationalization of the rupee is a process that involves increasing use of the local currency in cross-border transactions. As far as the rupee is concerned, it is fully convertible in the current account, but partially in the capital account. There is a need to push the rupee much farther to get an international tag as it accounts for a mere 1.7% of global foreign exchange market turnover as compared to 88.3% of dollar, followed by the euro, Japanese Yen and Pound Sterling.

Advantages of Internationalisation of Rupee

• Mitigates currency risk: Use of rupee in cross-border transactions mitigates currency risk for Indian business. Protection from currency volatility not only reduces cost of doing business, it also enables better growth of business globally.
• Less vulnerable to external shocks: Reducing dependence on foreign currency makes India less vulnerable to external shocks. For example, during phases of monetary tightening in the US and strengthening dollar, excessive foreign currency liabilities of domestic business results in a de facto domestic tightening such as during the “Taper tantrum’ episode of 2013.
• Reduces need for holding foreign exchange reserves: While reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy. This cost represents a transfer of income from India to Advanced Economies. Reducing the requirement of reserves would save some of this loss of income.
• Improve bargaining power: As the use of Rupee becomes significant, the bargaining power of Indian business would improve adding weight to the Indian economy, enhancing India’s global stature and respect.

However, internationalisation of rupee is not devoid of risks, highlighted as follows:

• Impact on monetary policy: Internationalisation can potentially limit the ability of the central bank to control domestic money supply and influence interest rates as per domestic macroeconomic conditions. Thus, macroeconomic policy would need to measure up to such risks.
• Dependence on foreign capital for growth: If a substantial portion of its trade is in Rupee, non- residents would hold Rupee balances in India, which would be used to acquire Indian assets. Such large holdings could heighten vulnerability to external shocks, managing which would necessitate more effective policy tools.
• Reduce reserve accretion: A reduced role for convertible currencies in external transactions could lead to reduced reserve accretion.
• The outflow of Hot money: Complete internationalization of currency will expand the risk of hot currency (highly prone to sudden outflows) to capital assets. For instance, a global risk-off phase could lead non-residents to convert their Rupee holdings and move out of India.

These risks are unavoidable if India progresses to be an economic superpower. We need to calibrate our moves to the evolving size of our economy as internationalisation would make domestic monetary policy more challenging but the alternative of compromising on growth by playing it safe is clearly not an optimal choice.