Globalised rupee

During PM Modi’s visit to Abu Dhabi this month, India and UAE signed a rupee-dirham deal to ease the path for trade between the two countries by lowering transaction costs and making it easier to convert the currency.

The push to establish a framework for enabling the use of the two countries’ local currencies for cross-border transactions is aimed at reducing their dependence on a third country’s currency such as the US dollar which is used as an intermediary for settling transactions.

Per the agreement, all current account payments, which includes those pertaining to exporters and importers from the two countries, and specific, permitted capital account transactions can be settled using either the dirham or the rupee. There is good reason to think on these lines. Since the implementation of the Comprehensive Economic Partnership Agreement between the two countries in May 2022, India-UAE trade has increased 15%.

Bilateral trade including oil purchases have hit $85 bn, of which UAE exports to India comprise about $50 bn. The agreement to help increase the circulation of the rupee in the Gulf countries could mitigate the ordeals of the large Indian diaspora in the Emirates.

Since the end of World War II, global trade has been based on the dollar. The US and its allies have also increasingly opted for financial sanctions as a weapon of choice. As much as 30% of all countries now face sanctions from the US, the EU, Japan, and the UK, which is up from 10% in the early 90s.

The polycrisis precipitated by the Russia-Ukraine war and sanctions imposed on Russia has taught emerging economies that any one of them could be a target of embargo. Bilateral trade in local currencies could prove to be an critical element in the new emerging world order. Brazil’s new government under President Lula Da Silva announced local firms can settle their foreign trade using Chinese yuan.

The yuan is now the most actively traded currency in Russia. It is ambitious for India to nurture dreams of globalising the rupee, but we must understand the ground realities. The use and the contribution of the rupee in global trade is meagre right now.

The daily average share of the rupee in the global forex market hovers around 1.6%. India’s share of the global goods trade is just about 2%. Compare this to the US dollar’s dominance in all aspects of trade and foreign currency reserves. Per IMF reports, the dollar’s share of foreign exchange reserves have fallen over time.

Even so, from 80% in the 1970s, it still holds onto a substantial figure of 60% in 2022. The dollar accounts for 90% of the global forex transactions. Even 80% of India’s foreign trade is invoiced using the dollar. Encouragingly, India is the world’s largest recipient of foreign remittances.

Per World Bank estimates, India is the first nation to receive an annual remittance flow exceeding $100 bn. But, for the rupee to be considered a reserve currency, it needs to be fully convertible, readily usable, and available in ample quantities. India does not permit full capital account convertibility (free movement of local financial investment assets into foreign assets and vice-versa).

There are barriers on exchange of currency with others, and it is subject to exchange rate volatility as well. India must strike a balance to trade off rupee convertibility for exchange rate stability. The RBI should pursue additional currency swap agreements (like with Sri Lanka) and also work towards building a more liquid rupee bond market, which will enable foreign investors and Indian trade partners to have more investment options in rupees.