By Anjan Roy
India is working out local currency trade deals with an increasingly larger group of countries, thereby avoiding invoicing in US dollars for every trade. This is a move towards internationalisation of the Indian currency when the country is opening up its external sector.
India has agreed on local currency invoicing of trade with United Arab Emirate during prime minister’s visit to that country last week. The Reserve Bank of India has signed an agreement with the central bank of UAE. Later still, the finance minister, Nirmala Sitharaman, has proposed a similar arrangement for trade with Indonesia.
While the UAE deal is done, the arrangement is to be yet finalised with Indonesia, which was proposed during the G20 meet of finance ministers in Gandhinagar. The Indonesians are further considering using the Indian digital payments platform, UPI.
While these arrangements have major positive aspects, there are some areas of concern as well. If India is really successful in proliferating such deals with sufficient number of countries, this would be a major advancement towards raising the Indian currency’s status in International financial transactions. Eventually, India could claim to post its currency as one of the most acceptable one with the IMF.
But that calls for stabilisation of the Indian rupee exchange rate with other major currencies, like the US dollar and the euro of the European Union. With all its shortcomings, like the stranglehold of the US over the global financial system, the US dollar is the prime reserve currency for global trade. This is the most widely used currency.
Not only that. The US dollar is the global store of value. This is a very important attribute of any kind of money — that it is a store of value. As a corollary, countries having surplus in their external trade keep their accounts in the US currency, apart from denominating their trade in the US dollar.
For instance, global oil trade is conducted primarily in US dollars and all countries square their accounts with US dollar. The trouble with this system is that at times of war and conflict, the US dollar is also a weapon. US sought to punish Russia for its Ukraine war by denying it access to the dollar. Similarly, dollar was denied to Iran for pursuing its nuclear weapons programme. US imposed sanctions against the truant countries could be enforced with the dollar as a weapon.
China sought to preempt its vulnerabilities with the US dollar as a medium of trade. Since China’s global trade is huge and its has developed enormous economic clout, the country sought to promote use of the Chinese currency, the renminbi, as a medium of trade. It also sought to push its currency as one of the select band in IMF’s special currency basket— the SDR.
However, internationalising a currency imposes some costs and limitations. Chinese currency could not so far became a widely accepted one for trade mill because its currency is not fully convertible and there are restrictions on trading in the currency.
Additionally, it is believed the renminbi is not a fully market-driven. Its exchange rates are manipulated by the country’s central bank and tuned to its internal economic compulsions. The currency is not let to float to find its true market determined change rate.
Exchange rate depends, among many other vagaries of the market, on the interest rate of the relevant central bank and its management of the monetary policy. If you currency is truly exchangeable on the global markets, then you can’t fix the exchange keeping in mind the domestic monetary policy needs. Because a change in interest rate, which for the domestic economy is the primary policy instrument, will influence the exchange rate through flow of capital.
Consider a country which has put its trust into your currency and put some part of its wealth (say, surplus in its tree account) in your currency, and it depreciates against other currency on account of your monetary policy changes. The country trusting your currency and using it will face a loss in its value. It will withdraw from your currency and that will put further pressure on your exchange rate.
This is how the British pound sterling lost its prime reserve currency status during the period when its domestic economy was facing various problems. Of course, there were other compulsions as the importance of the British economy was rapidly shrinking. After all, currency will eventually reflect the economic reality of a country.
There was a time when the Indian currency was virtually the legal tender in wide areas of the Middle East. However, it was a shock when India had devalued its currency in 1966 and it meant widespread loss of wealth for the Middle East countries. Very fast, India rupee was out of usage in these countries.
India had local currency trade arrangement with Soviet Union for decades until after “Perestroika” during the Gorbachev era’s hastened its end. Russia had then sought to reorient itself with the West and Indian goods and services went down in the Russian’s wanted list. Everything from designer brands to articles of daily consumption were sought from the West.
Indian trade with Russia became totally lop-sided. India continued to buy hue volumes of high value weapons systems while Russians stopped demanding even Indian teas. Russia accumulated large surplus.
When surplus and deficits become too large and trade imbalanced, the difference has to be settled in global reserve currency. The Russian dues against India were evaluated and had to be settled over years.
Take for instance India’s trade with UAE. The latter has a trade surplus. Even after trade is conducted in rupee-dirham, eventually India will have to settle the outstanding with the UAE. Will the latter then accept a hoard of India rupee in its central bank.
Hopefully, with India growing and its products increasingly in demand globally, Indian currency will become widely acceptable. It should be possible then for an Indian to go around the world with a purse-full of Indian currency and settle all account in own currency, just as the American can do it now. But before then, India will have to earn it through developing its economic muscles and wide ranging trade and a fully convertible currency.(IPA Service)
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