What is an International Currency?

• An international currency is used and held beyond the borders of the issuing country for transactions between residents and non-residents, and between residents of two countries other than the issuing country. 
• An international currency is supposed to perform three international functions:
  • Store of value: The governments can use them in their international reserves.
  • Medium of exchange: International currency is used for invoicing of trade and in financial transactions.
  • Unit of account: They are used as an anchor for pegging local currency or for denominating trade and financial transactions.

• In the current international monetary system, the US dollar is the most important international reserve currency. While the US dollar’s 50-year long dominance remains unchallenged for now, it has started to erode slowly, and the economic order will have to evolve to look beyond the US dollar in the future.
• Meanwhile, the international monetary and financial system has moved towards being multipolar. This is apparent as the share of USD in foreign exchange reserves of countries is steadily decreasing. On the other hand, we can see the increasing usage of other currencies in trade invoicing and settlement, and the emergence of various bilateral and regional economic cooperation agreements. 
• This, along with recent geopolitical developments, has set the stage for the emergence of various other currencies, including the Indian National Rupee (INR), as prospective currencies for use in international transactions.

Benefits Associated with Internationalisation of Rupee

• Limits Exchange Rate Risk: As the internationalisation of a country’s currency broadens and deepens its financial market, domestic firms may be able to invoice and settle their exports/imports in their currency, thus shifting exchange rate risk to their foreign counterparts. It also permits domestic firms and financial institutions to access international financial markets without assuming exchange rate risk. 
• Reduces the Cost of Capital and widens the set of financial institutions that are willing and able to provide capital. This would boost capital formation in the economy thereby increasing growth and reducing unemployment.
• Financing Deficits in Domestic Currency: It allows a country’s government to finance part of its budget deficit by issuing domestic currency debt in international markets rather than issuing foreign currency instruments. It may, likewise, allow a government to finance its current account deficit without drawing down its official reserves. 
• Reduces the Requirement for Maintaining Large Forex Reserves: The authorities maintain and depend on large foreign exchange reserves in convertible currencies to manage external vulnerabilities. 
• Lowers the Impact of Capital Outflows: At the macroeconomic level, internationalisation of a currency results in lowering the impact of sudden stops and reversals of capital flows and enhances the ability to repay external sovereign debt.

Past and Current Initiatives Towards the Internationalisation of Rupee

• Bilateral Swap Arrangements (BSA): India currently has a BSA with Japan for an amount up to USD 75 billion as a backstop line of support in case of any balance of payments issue. RBI also provides liquidity to South Asian Association for Regional Cooperation (SAARC) countries under the SAARC swap framework. Under the SAARC swap agreement, the requesting central bank can make withdrawals in USD, Euro and also in INR.
• Developments in the GIFT City: Gujarat International Finance Tec-City (GIFT City), Gandhinagar was set up as India’s first International Financial Service Centre (IFSC) with a vision to bring to the Indian shores, those financial services/markets and transactions, relating to India, that are currently done outside India. GIFT IFSC has the potential to develop as a competitor to international financial centres for Rupee products. It also provides an opportunity for Indian entities to raise foreign capital through masala bonds and list the same on the exchanges in the IFSC.
• Indo-Iran Agreement: An agreement was signed between India and Iran for undertaking eligible trade transactions using INR. In terms of the existing Arrangement for Bilateral Trade Payments between India and Iran (2018), it was decided that Indian Rupee vostro accounts may be opened by designated Iranian banks. Under the arrangement, the Indian Rupee vostro accounts of Iranian banks are credited 100 per cent in INR by Indian importers, against invoices payable for the supply of goods and services from entities in Iran, without the requirement of any additional certification or authorization.
• Asian Clearing Union (ACU): The idea of initiating the use of domestic currencies within the ACU mechanism is to facilitate the process of internationalisation of INR on a pilot basis in a closed environment where the framework can be tested, and various operational glitches and roadblocks could be addressed. Accordingly, RBI had proposed the use of local currencies of members for settlement of ACU transactions thus mooting the idea of INR also being included as one of the settlement currencies under the ACU.
• INR as a Designated Foreign Currency in Sri Lanka: An arrangement for payment and settlement of exports/imports in INR has been put in place. This has been done to promote the growth of Indian trade with partner countries with an emphasis on export promotion and to support the increasing interest of the global trading community in INR. In 2022, Sri Lanka also made Rupee a designated foreign currency. These steps have paved the way for INR-based bilateral trade between Sri Lanka and India.
• Use of Indian Payment Infrastructure: RBI in collaboration with the GoI and National Payments Corporation of India (NPCI) is reaching out to jurisdictions to increase the global outreach of the UPI system to facilitate cross-border transactions, including remittances. The linkages between fast payment systems across jurisdictions can enhance cross-border payment arrangements and ensure faster remittances.

Challenges Associated with Internationalisation of a Currency

• Volatility of Exchange Rate: It may result in the potential increase in volatility of its exchange rate in the initial stages. 
• Monetary Policy Implication: This would further have monetary policy implications as the obligation of a country to supply its currency to meet the global demand may come in conflict with its domestic monetary policies objectives. This is popularly known as the Triffin dilemma (impossible trinity) – meaning no country can simultaneously reach the policy goals of free capital movement, exchange rate stability, and independent monetary policy.
• Accentuate External Shocks: The internationalisation of a currency may accentuate an external shock, given the open channel of the flow of funds into and out of the country and from one currency to another.
• Uncertainty in Estimation of Foreign Demands: The costs also emanate from the additional demand for money and also an increase in the volatility of the foreign demand for domestic currency in the international market. Despite advances in statistical reporting, there remains an uncertainty associated with demand estimation.

Way Forward

Internationalisation of Rupee has significant benefits but to achieve it successfully, would require some prerequisites:

• Capital Account Convertibility: Internationalisation of rupee would require continued efforts to improve macroeconomic fundamentals and financial market infrastructure with an enhanced risk management framework. Hence, it is essential to continue on a calibrated path towards current account convertibility.
• Liquidity in Indian National Currency: Encouraging the international usage of rupee requires that sufficient rupee liquidity is available at the government and central bank levels (both domestic and foreign). This will provide the requisite confidence to all stakeholders, economic agents and market participants for settling cross-border transactions in Indian Rupee.
• Cross-border Payment Infrastructure: Availability of a robust INR-denominated payment mechanism for cross-border transactions and providing timely inter-bank transfers and settlement is an important step towards the internationalisation of INR. This ensures a seamless flow of cross-border transactions in local currencies. It may also reduce our dependence on international payment systems based on the SWIFT messaging system.
• Easing Regulatory Hurdles: Easing of Foreign Exchange Management Act, 1999; revisiting regulatory guidelines to remove frictions in the current Financial Action Task Force (FATF) and Prevention of Money Laundering Act (PMLA) provisions would be very important in this regard. Further, procedural and documentation roadblocks faced by foreign portfolio investors need to be reviewed. These roadblocks not only add to transaction and compliance costs but also affect the overall ease of doing business in India.
• Deepening Indian Financial Markets: Well developed and sophisticated domestic financial markets give confidence to foreign investors to take exposure in the underlying currency.
• Making Rupee the “Vehicle Currency”: As we progress and achieve a higher level of trade linkages with other countries, along with greater capital account convertibility, deep and liquid financial markets and strong macroeconomic indicators, it is expected that Rupee would be used by other economies for pegging their currencies, which will fulfil the requirement of Rupee being used as a “vehicle currency” by other jurisdictions in their forex intervention to maintain the value of their currency. Inclusion of Rupee in the International Monetary Fund’s (IMF) SDR basket will further help in attaining the objective of INR as a “vehicle currency”.

ConclusionAs the internationalisation of a currency is a long-drawn process involving continuous change and incremental progress, it would enable timely redressal of the associated concerns and challenges as we move forward.