By Subrata Majumder
The RBI’s decision to allow the convertible rupee for export and import is a precursor to making the rupee an international currency. Although convertibility is limited to the current account, the RBI’s decision demonstrates that India is ready to move forward for full convertibility.
The essence of rupee convertibility is a challenge for the global economy due to India’s strong macroeconomic fundamentals. The strong rebound in the economy, with GDP growth of 8% in 2022-23, after a 7% drop in 2021-22, outpaces Chinese growth, which is expected to reach 4% over the same period.
The rupee has played a paradoxical role in the foreign exchange market. While it plunged against the US dollar, it appreciated against other major currencies. 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. It ensures that strong macroeconomic fundamentals insulate the rupee. In other words, the fall of the rupee was not due to the bad health of the economy. Capital flight by US investors into the REIT due to the Federal Bank’s high interest rate caused the rupiah to fall against the dollar.
Dedollarization has emerged as a new wave in world trade. It has been alleged that the United States is arming the dollar to exert influence on the global political landscape. The imposition of sanctions and the exclusion of SWIFT (Society for Worldwide Interbank Financial Telecommunication) triggered 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 at “US financial hegemony turning against them 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 a block that “the share of US dollar assets among foreign exchange reserves has fallen to its lowest level in 25 years.”
The fall 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 expresses certain trades and investments in RMB. In 2016, the IMF included the RMB in IMFSDRs (Special Drawing Rights), as China became an important global trading partner.
In the aftermath, Russia accelerated the dedollarization movement in 2014, when the United States imposed sanctions on Russia for annexing Crimea to Ukraine. There are three ways Russia has reduced 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 give preference to trade in national currencies. In the fourth quarter of 2020, Russian exports to the BRICS, invoiced in US dollars, fell to 10% in 2020, compared to 95% in 2013.
Russia has developed its own financial transfer system SPFS (Financial Message Transfer System) – to allow American allies to pay for oil and gas in Rubble, after the United States demanded that Russian banks be disconnected from Swift.
In-depth analysis indicates that the 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. This is because since 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 set exchange rate. Given these, exporters can get more rupees than 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. Currently, almost all oil imports are made in US dollars. The surge in oil imports is due to an unprecedented rise in oil prices as well as the fluctuation of 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.
Days are coming when the rupee will tend towards full convertibility. Fully convertible means fully convertibility of the capital account in the balance of payments. It 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 relatively lower rates.
Nevertheless, there is a catch. The Rupee may be overshadowed by global currency market volatility. It can also lead to an increase in external debt. (IPA)
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