Rupee convertibility: Dedollarization paves the way for a stronger rupee – Analysis – Eurasia Review
The decision of the Reserve Bank of India (RBI) to allow the rupee in world trade is a precursor to making it an international currency. The RBI said the move was to “support growing interest from global trading companies”. Although convertibility is limited to the current account, meaning partial convertibility, the RBI’s attempt demonstrates India’s willingness to move towards full convertibility.
Even though the decision was taken amid the Rupee’s alarming fall against the US Dollar, the RBI’s decision is a challenge given that strong macro fundamentals will insulate the Rupee. The sharp rebound of the economy with the fastest recovery growth in the world is a good example. India’s GDP is expected to grow by 8% in 2022-23, after falling by 7% in 2021-22. India is expected to outpace Chinese growth, which is expected to reach 4% over the same period.
The paradox of the Rupee’s fall against the US Dollar is that it has appreciated against all other major currencies, such as the Japanese Yen, Euro and British Pound. In other words, it reflects that the fall of the rupee is not due to the poor health of the economy. The reality is the flight of capital from US investors into REITs due to high Federal Bank interest rates. Between February and June 2022, the rupee fell by more than 4% against the US dollar. On the contrary, it appreciated by 2.8% against the euro, by 10.4% against the Japanese yen and by 3.3% against the pound sterling.
De-dollarization emerged as a new wave in global trade after it was alleged that the United States was weaponizing the dollar to exert influence on the global political landscape. Trade analysts argued that the imposition of sanctions and the debarment of SWIFT (Society for Worldwide Interbank Financial Telecommunication) sparked the wave. Currently, 70% of world trade goes through the US dollar and 60% of the world’s foreign exchange reserve is stacked in US dollars.
Dedollarization is a challenge against US dominance in currency influence. The Chinese have argued that the US dollar gives disproportionate power to influence the global economy. Eventually, the power of the US dollar was used to drain the economies of countries hostile to the United States. Chinese media Xinhua scoffed: “US financial hegemony is turning against us as countries opt for de-dollarization.”
As a result, the share of the US dollar in global foreign exchange reserves has declined. IMF economist Desmond Lachman wrote in an article: “the share of US dollar assets among foreign exchange reserves has fallen to its lowest level in 25 years”
The fall in the importance of the US dollar has led hostile countries like China and Russia to adopt alternatives to the dollar. The Chinese government has pressured its trading partners, including Russia, to denominate some trade in RMB (Renminbi – a Chinese currency). It has established an RMB trading center in Hong Kong, Singapore and Europe and created a cross-border exchange connection program that denominates certain trades and investments in RMB. In 2016, the IMF included the RMB in the IMF’s SDRs (Special Drawing Rights), as China became an important global trading partner.
In the aftermath, Russia accelerated its dedollarization movement in 2014, when the United States imposed sanctions on Russia for annexing Crimea to Ukraine. Russia has three ways to reduce its dependence on the dollar. First, Russia’s central bank cut its US dollar reserves by more than half between 2013 and 2020. Second, Russia had several discussions with China, India, Turkey and members of the Eurasian Economic Union (Armenia, Belarus, Kazakhstan and Kyrgyzstan) to favor exchanges in national currencies. In the fourth quarter of 2020, Russian exports to the BRICS, invoiced in US dollars, fell to 10% in 2020 from 95% in 2013.
Russia has developed its own financial transfer system SPFS (Financial Message Transfer System) – to allow US allies to pay for oil and gas in rubble, after the US demanded that Russian banks be disconnected from Swift.
A closer look reveals that a convertible rupee may gain strength on demand for de-dollarization. As China – one of India’s two main trading partners – moves towards de-dollarization and Russia becomes a major supplier of crude oil after the current oil shock, the wave of de-dollarization is taking advantage of new opportunities for the rupee to be stronger.
Also, a number of benefits can be derived from the convertibility of the rupee. First, the internationalization of the rupee will accelerate exports. Exports become more profitable thanks to convertibility. Indeed, as the rate of the rupee will be determined by the market exchange rate and not by government intervention, the market rate is usually higher than the official exchange rate set previously. Given this, exporters can get more rupees than foreign currencies, for example, the US dollar, which was officially fixed before.
Second, invoicing in rupees in trade will isolate currency risks. Importing crude oil is a good example. The surge in crude oil imports, one of the main import burdens, is due to the unprecedented rise in oil prices and fluctuations in the US dollar. In 2021-2022, India’s crude oil imports increased by 93.5% in value. But, in quantity, it only increased by 7.8%.
Third, it provides incentives to NRIs for remittances. Eventually, it helps to increase foreign exchange reserves.
The days are ahead, the rupee could move towards full convertibility. Full convertibility means full convertibility of the capital account in the balance of payments. This opens the market to foreign investors, businessmen and business partners. It encourages FDI flows and the free movement of capital. Local businesses will have easy access to the foreign capital market for loans at comparatively lower rates.
However, there is a catch. The Rupee could be overshadowed by global volatility in the currency markets. In such a case, it can also act to increase the foreign debt.