The year 2014 is likely to close with the Indian rupee among the best performing major emerging market currencies against the US dollar. The fall in rupee value over the year has been marginal even while some of the other emerging market currencies have seen a free fall. Improved macro fundamentals including the current account deficit, domestic inflation along with prospects of positive and stable growth have helped contain capital outflows from India even as expectations of higher interest rates in the US draw money back from other emerging markets. It may be time therefore to consider using the rupee as the regional currency, a move that can contribute to enhancement of intra regional trade in South Asia. In neighbouring East Asia, China initiated the process in 2009 and is well on its way to internationalising the renminbi. India formed a task force for the purpose in 2013 with little progress thereafter.
Currency internationalisation involves the use of a currency instead of national currencies, by residents and non-residents, for all international transactions whether they be purchases in goods, services or financial assets and requires full capital account convertibility and a flexible monetary management framework. As seen appropriate for South Asia, a limited version of the concept that involves the currency usage, in this case, of the rupee, in trade invoicing and settlement within the region, could be useful. Rupee regionalisation in this manner will help enhance regional and bilateral trade through reduced transaction costs and exchange rate risk, the latter having been significantly brought forth vis-à-vis advanced market currencies during the global financial crisis. Countries with a trade surplus can maintain rupee receipts as rupee bank deposits which can subsequently be invested in rupee denominated financial assets through offshore/onshore markets. In case of a trade deficit, bilateral rupee-local currency swap lines between the Reserve Bank of India and the central bank of a regional economy can be negotiated to enhance their liquidity position. Additionally, South Asian economies can maintain smaller dollar reserves or allow for greater currency diversification in reserve accumulation. This will imply lower risk exposure and hence costs given that ‘store of value’ properties of advanced economies’ currencies are increasingly being questioned.
Some facilitating factors in this regard such as India’s centrality to regional trade, its economic size, macroeconomic stability and use of rupee in cross-border trade with Nepal and Bhutan already exist. Further, India has already assumed the role of liquidity provider with its regional swap arrangements. India and Bhutan have a currency swap agreement signed between the Reserve Bank of India and the Royal Monetary Authority of Bhutan (RMAB) for US$100 million. It enables RMAB to make withdrawals of US dollar, euro or Indian rupee in multiple tranches up to a maximum of US$100 million or its equivalent. In May 2012, RBI had announced it would offer swap facilities aggregating US$2 billion, both in foreign currency and Indian rupee, to SAARC member countries. The arrangement would be for a three-year period and would help bring financial stability in the region. However, these swaps are denominated in dollars and earmarked only as a line of reserve for partner countries during a balance-of-payment crisis; it is not for enabling trade payment.
India is also in the process of developing local currency offshore bond markets. The International Finance Corporation (IFC), an arm of the World Bank Group, in 2013 launched a US$1 billion off shore rupee linked bond programme. The bonds to be bought and sold in dollars are denominated in rupees and offer returns linked to rupee interest and exchange rates. They have a triple-A rating guaranteed by the IFC. A series of these bonds are to be issued by the IFC and proceeds will be invested in government and corporate bonds. The bilateral swap arrangements and the offshore market activity are both indicators of the strength and credibility of the Indian rupee.
China has a far more ambitious programme and aims at internationalisation of its currency with regionalisation as only a step in the process. The centrality of China in the regional trade and production networks has been at the base of the expanding ease and use of its currency in trade settlements throughout East Asia. China initiated a pilot program for renminbi internationalisation in 2009 with renminbi (RMB) settlement of cross-border trade in a limited number of cities and regions that was later expanded in geographical coverage and scope of eligible transactions. Linkages between offshore market and onshore market have been set up. Onshore financial markets have been steadily opened to foreign investors. Banks outside mainland China participating in cross-border trade settlement transactions can invest their RMB funds in the interbank bond market in mainland China. China has also signed bilateral RMB-local currency swap agreements with central banks or monetary authorities of 23 countries. Even while negotiating FTAs with regional partners, China has been vigorous in elevating the status of its currency, the renminbi (RMB), to a regional unit of accounting and exchange.
While internationalisation of Chinese currency would need to be supported by large scale domestic financial sector reforms and call for some serious pondering on its implications for international currency and reserve mechanisms, India can move ahead with regionalisation of the rupee with the available financial infrastructure in its limited task of trade enhancement in a region specific context.