Rupee is a long way from replacing the dollar

The end of dollar supremacy is not a far-fetched dream. As regional integrations grow stronger and discussions of using alternative regional currencies for settlements gain traction, the dominance of the dollar will gradually diminish and eventually be replaced. However, this transition will not occur in the immediate future, contrary to what some may want us to believe. Currently, the US dollar continues to hold many significant advantages in the global financial system, thanks to its status as a strong reserve currency, the petrodollar system, and other geopolitical factors.

In a bold move aimed at promoting the internationalisation of the Indian rupee, we recently engaged in a trade agreement with 18 countries that allow settlements in our local currency. The idea is to enable these countries to open Special Vostro accounts in Indian banks, allowing them to hold and utilise Indian rupees for their purchases from India. While this initiative may seem promising, recent discussions with Russia have shown the challenges to its successful implementation.

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Russia has expressed concerns regarding the accumulation of billions of rupees that they are unable to effectively utilise. Notably, India’s total exports to Russia have decreased to $2.8 billion in the first 11 months of 2022–23, whereas imports from Russia have surged to $41.56 billion. These figures indicate a significant trade imbalance, suggesting that Russia will consistently have a surplus rupee balance due to the disparity between our exports and imports. Additionally, India’s crude oil imports from Russia have been steadily increasing and are expected to rise further.

Russia has been supplying crude oil to India below the price cap of $60 per barrel, which has played a crucial role in keeping Indian inflation
below 6%.

However, offering discounts to maintain crude oil prices below $60 per barrel poses economic challenges for Russia, as other buyers like China are willing to absorb the excess supply. Recent reports indicate that China has substantially increased its oil imports from Ural, a major Russian crude oil supplier,
by 27.5% in March and 37.4%
in April 2023.

Other countries that have a trade surplus with India may raise the same question of utilising their surplus rupee balance. In response, the Reserve Bank of India (RBI) has clarified that the surplus rupee balance can be used for various current and capital account transactions based on mutual interests. This includes options such as financing projects and investments and investing in government securities and Treasury bills, among other avenues. Currently, India has a trade deficit with many countries, including Singapore (-11.60), Malaysia (-5.58), and Germany (-5.80), which are part of the 18 countries
with whom we have entered
into a trade settlement in
Indian rupees.

The twist here is that India has a partially convertible capital account. The capital account records the movement of capital via investments and loans between a country and the rest of the world. A fully convertible capital account would mean that foreign investors could acquire assets in India without any restrictions, and conversely, Indian investors could freely convert any amount of rupees to purchase assets in foreign countries. As former deputy governor of RBI Syamala Gopinath noted, allowing both residents and non-residents to freely buy and sell domestic currency could undermine the effectiveness of monetary policy. A fully convertible capital account would entail a floating exchange rate regime where the Reserve Bank of India (RBI) would refrain from intervening to prevent currency volatility. Under such circumstances, the RBI would also not have much control over the money supply and interest rates, as they would no longer be determined based on domestic market conditions.

A careful and measured approach is crucial when considering the implementation of the plan to make the rupee internationally acceptable. It is evident from the latest BIS Triennial Central Bank Survey 2022 that the US dollar remains the dominant currency, with a substantial share of 88 percent in global forex turnover. In comparison, India’s share stands at a modest 1.6%, showing a slight increase of 0.7% since 2007.

While the RBI’s Currency and Finance Report 2020–2021 states that making the rupee internationally acceptable is ‘inevitable,’ it is important not to rush the process. Instead, considerable thought and planning should be invested to ensure a smooth and well-considered transition.

(The writers are assistant professors at TAPMI, Manipal.)