Indian Rupee as an International Currency: Current Status

Introduction

There is continued deliberation regarding the future of the International Monetary System. Following the international economic and financial crisis, compounded by the rise of China as the second-largest economy and the widespread circulation of the Euro, debate has grown over other currencies joining the U.S. Dollar as the reserve currency of the IMF. This report examines the prevailing position of the Indian Rupee in terms of becoming an international currency and its potential role in the International Monetary System. India has emerged as the fastest-growing major economy in the world. The enhancement of the nation's economic fundamentals accelerated in 2015 with the combined impact of strong government reforms. Taking into account the characteristics of an international currency — such as those of the U.S. Dollar and the Euro — the current status of the Indian Rupee has yet to solidify as an international medium of exchange. The Indian Rupee fails to satisfy the features of a global currency. The nation needs significant improvement in its GDP, its foreign exchange turnover rank, and its share of world trade.

In recent years, there has been considerable debate over the future of the International Monetary System. The global economic and financial crisis cast doubt on the prevailing global exchange rate system. Persistent instabilities in exchange rates — whether between the U.S. Dollar and the Euro or among currencies in Eastern Europe — repeatedly generate uncertainty in financial markets. Similarly, fixed exchange rates, such as those between China and the United States, underpin the accumulation of major imbalances (Belke et al., 2011). Since the Second World War, the United States Dollar has served as the reserve currency of the International Monetary Fund. However, forthcoming periods may see other currencies — including the Chinese Renminbi, Indian Rupee, and Brazilian Real — becoming part of a multi-polar currency system alongside the Dollar and Euro (Kadyan, 2014).

The Indian economy is among the emerging economies of the globe, experiencing a high growth rate. The nation's market share in global trade has also increased in recent years. Given the size of the nation and its future prospects, India cannot be overlooked. India is also steadily growing as a sought-after destination for Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII). Furthermore, there has been a progressively increasing demand for the Indian Rupee in global financial markets, to the extent that a number of transnational institutions have begun to issue financial bonds denominated in Indian Rupee (Kadyan, 2014). This suggests that there are reasonable prospects for the Indian Rupee becoming an international currency. The purpose of this report is to examine the different factors that influence this prospect in relation to the international monetary system.

The following research questions are evaluated in this report:

1. Taking into account the characteristics of an international currency within the international monetary system — such as the U.S. Dollar and the Euro — what is the current status of the Indian Rupee at the international level?

2. What are the aspects that aid in making a currency a global or international currency, and where does the Indian Rupee stand with regard to these aspects?

3. What role is the Indian Rupee going to play in the future as an offshore currency, taking into consideration the nation's efforts to increase local currency trade?

Literature Review

The International Monetary System has evolved through distinct phases: the gold standard era (1819–1914), the interwar period (1914–1939), the post-World War II Bretton Woods System (1946–1973), and the present post-Bretton Woods System (1973 to the present) (Lin et al., 2012). During the gold standard epoch, the majority of nations operated on some form of the gold standard; however, China and India were notable exceptions, maintaining a silver standard. In the interwar phase, the UK and the U.S. were permitted to hold gold reserves, while other countries could hold both gold and pounds or dollars as reserves, with the aim of avoiding a gold shortage. The Bretton Woods System established fixed exchange rates against the U.S. Dollar, which carried a fixed gold price of U.S.$35 per ounce (Lewis, 2015). Following the collapse of the Bretton Woods System, the fixed gold price was abandoned. To the present day, the dollar has maintained its dominant position in the international monetary system.

In accordance with basic monetary economics, money serves three elementary functions within an economy: as a unit of account, as a medium of exchange, and as a store of value. An international currency serves equivalent functions across numerous economies. As a unit of account, an international currency is used to price traded commodities, to denominate financial transactions, and to define exchange rate parities (Tavlas, 1998). As a medium of exchange, an international currency is used in the direct exchange of currencies and as a vehicle currency in executing indirect exchanges between two other currencies in foreign trade and global capital transactions. It is also used to finance balance of payments and as a vehicle for exchange market intervention. As a store of value, an international currency is employed in the selection of financial assets — such as financial bonds — and held as a reserve (Tavlas, 1998).

Kadyan (2014) identifies the main characteristics of an international currency as: international financial market domination, invoicing currency function, pegging currency function, reserve currency function, and hand-to-hand currency function. International currency is employed for pricing international trade — in particular, it is used even when neither partner in a trade transaction is from the country of origin of that currency (Kadyan, 2014). Krugman (1984) illustrates this point using the U.S. Dollar. In goods trade between any two nations, there is a preference for demanding payment in the exporter's currency, but also a preference for demanding payment in the currency of the larger nation. This gives the United States, as the largest economy in the world, a disproportionate share of invoicing. Moreover, a great deal of trade — regardless of whether it involves the United States — is invoiced in dollars. In monetary transactions, the dollar is the prevailing currency for global borrowing and lending, though this dominance is not absolute (Krugman, 1984).

International currency is also used for denominating securities in the global financial market, and the majority of global securities are issued in the leading international currency (Blinder, 1996). The role played by an international currency in the global financial market is measured by the foreign exchange revenue of a currency, cross-border claims, and global debt or bond securities denominated in that currency (Kadyan, 2014). According to Goldberg and Tille (2008), a currency is considered a hand-to-hand currency at the global level when it is used by non-residents for their transnational trade payments and for everyday domestic use as well. In nations with high inflation, even resident trading may be conducted in a foreign currency — either formally, through a process also known as dollarization, or informally. In numerous nations, the U.S. Dollar is used as the second major currency or has entirely replaced the local currency (Goldberg, 2010). The Indian Rupee functions as a hand-to-hand currency in a limited number of countries. According to Kadyan (2014), the Indian Rupee is accepted in Bhutan and parts of Nepal, and is also used to some degree in Sri Lanka, Malaysia, Indonesia, Singapore, and the United Kingdom. Therefore, while the Indian Rupee does function as a hand-to-hand currency in several locations, its role is very minor as an international medium of exchange (Kadyan, 2014).

Pegging refers to the fixing of an exchange rate between two currencies. This occurs when a nation ties its currency to another and subsequently endeavors to maintain a fixed exchange rate between them (Page, 1981). This is typically achieved through intervention by the government or central bank in the foreign exchange market. Generally, pegging is undertaken either to a key trade partner's currency to reduce exchange rate volatility, or to a strong currency to keep monetary and fiscal policies within defined parameters (Obstfeld & Rogoff, 1995; Kadyan, 2014). Three decades ago, the majority of world trade was pegged to the dollar. Today, only a limited number of smaller nations continue to do so. Nevertheless, this does not signal the rise of a competing currency so much as the broader abandonment of fixed rates (Krugman, 1984). According to Kadyan (2014), the Nepali Rupee and the Bhutan Ngultrum are pegged to the Indian Rupee. After the establishment of Nepal Rastra Bank in the early 1960s, the Nepali Rupee was pegged to the Indian Rupee at a rate of 1.6 Nepali Rupees per 1 Indian Rupee. In 1974, the Bhutan Ngultrum was introduced and immediately pegged to the Indian Rupee at 1 Bhutan Ngultrum per 1 Indian Rupee (Kadyan, 2014).

Invoicing Patterns and Reserve Currency Status

A key criterion for assessing the Indian Rupee as an international medium of exchange is the invoicing of exports and imports. The table below presents the currency-wise invoicing pattern of India's exports and imports as a percentage of total trade, sourced from the Reserve Bank of India.

Table: Currency-wise invoicing pattern of India's exports and imports (per cent)

The data show that the U.S. Dollar accounts for the vast majority of invoicing for both imports and exports in India, consistently exceeding the 80% mark. For exports, the share invoiced in dollars has been steadily increasing. For imports, the share denominated in dollars has similarly remained very high. The Euro ranks second, accounting for approximately 10% of invoicing. Other currencies — including the Pound Sterling, Japanese Yen, and the Indian Rupee itself — account for a negligible share of both import and export invoicing (Reserve Bank of India, 2014). Given that the overwhelming majority of India's imports and exports are invoiced in U.S. dollars, it is clear that the Indian Rupee is not currently used as an invoicing currency at the international level, and therefore does not satisfy the features of an international currency (Vageesh, 2014).

The global financial crisis prompted widespread questioning of the future of the international monetary system and the search for alternative reserve currencies. An international reserve currency is held by the central banks of nations as part of their official reserves. Reserves are typically held in currencies that are stable and likely to retain their value; fluctuations in exchange rates could alter the real value of official reserves, potentially harming central banks. It is therefore prudent to hold reserves in strong currencies. In recent periods, the U.S. Dollar and the Euro have dominated as reserve currencies. The table below, drawn from IMF data, presents the currency composition of global official foreign exchange reserves from 2007 to 2012.

Analysis of the IMF data shows that the U.S. Dollar accounts for more than 60% of official global reserves, though its share has gradually declined over the period. The Euro ranks second at more than 25%. The Japanese Yen and the Pound Sterling follow at approximately 4% and 3–4%, respectively. Other currencies have seen a modest increase in their share over recent years. Notably, the IMF data do not separately identify the Indian Rupee's share of global reserves, which implies that its share is either negligible or nonexistent. This indicates that the Indian Rupee is currently unable to serve the function of a reserve currency and has not yet attained the status of an international currency comparable to the U.S. Dollar (Kadyan, 2014).

Conclusion

In recent years, the debate over the future of the International Monetary System has intensified. China has replaced Japan as the second-largest economy in the world, and the Euro has become the largest single currency in circulation among European nations, reflecting the shifting global economic order. The Yuan is the leading currency in Asia, yet the Indian Rupee is not far behind. These developments will inevitably influence the future of the International Monetary System. For now, the U.S. Dollar remains the reserve currency of the International Monetary Fund; however, the future may involve other currencies playing a more prominent role. This report has assessed whether India and its currency are positioned to achieve international currency status.

According to Kadyan (2014), the main characteristics of an international currency include international financial market domination, invoicing currency function, pegging currency function, reserve currency function, and hand-to-hand currency function. While the Nepali Rupee and the Bhutan Ngultrum are pegged to the Indian Rupee, the currency still lacks significant dominance compared to the U.S. Dollar. The percentage of India's import and export invoicing conducted in U.S. dollars exceeds 80%, which demonstrates that the Indian Rupee is not currently used as an invoicing currency at the international level and therefore does not satisfy the features of an international currency (Vageesh, 2014). Other key elements — including GDP size, national economic scale, and global trade share — also fall short of the benchmarks set by established international currencies. India's GDP growth rate has slowed in recent financial quarters and failed to meet market expectations. India also lags considerably in global trade, which is a major stumbling block.

Taking into account the characteristics of an international currency within the international monetary system — as exemplified by the U.S. Dollar and the Euro — the current status of the Indian Rupee as an international medium of exchange has yet to solidify. The nation needs significant improvement in its GDP, its foreign exchange turnover rank, and its share of global trade before the Indian Rupee can realistically aspire to international currency status (Kadyan, 2014).

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