RBI’s Strategic Maneuvers: A Deep Dive into Rupee Stability and Internationalization

The Indian rupee has been a focal point of numerous discussions in recent years, particularly concerning its stability and the Reserve Bank of India’s (RBI) strategic moves to bolster its position both domestically and internationally. Governor Shaktikanta Das, in his interview with CNBC, emphasized that the rupee’s strength is not an artificial construct but rather a reflection of India’s robust economic foundations. This assertion is significant, especially in the context of the substantial foreign-exchange inflows India has been receiving, largely attributed to the inclusion of Indian bonds in global indices. Das’s comments come at a time when the rupee has demonstrated remarkable resilience, maintaining stability against the US dollar and exhibiting one of the lowest volatility rates among global currencies since early 2023.

India’s economic trajectory has been noteworthy, with the country expected to sustain an impressive growth rate of 8% in the medium term. This optimistic outlook is underpinned by strong economic fundamentals, which have been instrumental in attracting foreign investments. The central bank’s policies have played a crucial role in this regard, as evidenced by the RBI’s active intervention in the foreign exchange market to manage rupee fluctuations. By employing public sector banks as intermediaries to sell US dollars, the RBI has effectively mitigated excessive volatility, fostering confidence among market participants and investors. This approach aligns with the RBI’s stated policy of preventing undue fluctuations in the rupee, which could otherwise have detrimental effects on trade and investment activities.

The internationalization of the Indian rupee has been a long-standing goal for the RBI, with efforts dating back over a decade. In 2013, then-governor Raghuram Rajan predicted a shift towards more settlement in rupees as India’s trade expanded. This vision has gradually materialized, with significant milestones such as the recent announcement by Prime Minister Narendra Modi and Malaysian PM Anwar Ibrahim, allowing trade between India and Malaysia to be settled in Indian rupees and Malaysian ringgits. This move is part of a broader strategy to reduce India’s reliance on the US dollar, a goal further advanced by the RBI’s 2022 circular on ‘international trade settlement in Indian rupees’.

The practical implementation of this strategy saw the India International Bank of Malaysia operationalize the mechanism by opening a special rupee Vostro account in 2021. This step is crucial for enhancing India’s exports to Malaysia, which had stagnated in recent years, leading to a significant trade deficit. The use of the rupee for trade settlement gained further momentum as India sought alternative routes for conducting trade in response to Western sanctions on Russia following its invasion of Ukraine. The RBI’s framework for rupee trade settlement has since been adopted by banks from 18 countries, including Malaysia, facilitating cross-border transactions and reducing currency risk for Indian enterprises.

The push for rupee trade settlement is also seen as a strategic response to global economic uncertainties, such as the potential imposition of 100% tariffs by the US on countries not using the US dollar, as announced by former President Donald Trump. By implementing a rupee settlement mechanism, India aims to provide better market access for countries with scarce foreign exchange or facing sanctions, while also protecting Indian exporters from exchange rate fluctuations. This mechanism, which operates alongside the existing system of using freely convertible currencies, reduces dependence on hard currencies and offers additional benefits such as forward premium on foreign currencies for exporters.

Despite these advancements, the internationalization of the rupee faces challenges, particularly in balancing exchange rate stability with domestic monetary policy. While the RBI’s efforts have made significant strides, the full liberalization of the capital account remains a complex issue. Capital account convertibility (CAC), which allows for unrestricted capital movement for foreign investments and asset purchases, poses risks for an emerging market like India. Full CAC could lead to significant and abrupt inflows or outflows of foreign capital, potentially destabilizing the financial system. Therefore, the RBI’s approach has been cautious, aiming to gradually liberalize the use of the rupee while ensuring financial stability.

The concept of using the rupee for trade settlement has two primary advantages: it reduces currency risk for Indian enterprises and diminishes the need for maintaining an ‘adequate’ level of foreign exchange reserves. This is particularly relevant in the context of India’s economic interactions with countries like Russia, Sri Lanka, and the Maldives, which have already adopted the rupee settlement mechanism. The surplus rupee balance in special rupee vostro accounts (SRVAs) can be used for permissible capital and current account transactions, including investments in India, thereby enhancing the utility of the rupee in international trade.

One of the critical components of the RBI’s strategy is the establishment of local currency trade agreements with other countries. For instance, in 2023, India entered into such agreements with the UAE, allowing bilateral trade to be conducted in either the rupee or dirham. This not only reduces reliance on the US dollar but also promotes the use of the rupee in international transactions. The RBI has also promoted the use of rupee vostro accounts to facilitate rupee-denominated trade, further integrating the rupee into the global financial system. However, the path to full internationalization is fraught with challenges, requiring careful planning and consideration to avoid adverse impacts on the economy’s fundamentals.

The RBI’s measured approach towards capital account convertibility reflects its commitment to balancing liberalization with financial stability. While the ultimate goal is to enhance the international use of the rupee, the process involves gradual steps, such as allowing Indian citizens to open foreign bank accounts. This cautious stance is essential given the uncertainties in the global economic landscape, which necessitate a stable and resilient financial system. The RBI’s interventions in the foreign exchange market, coupled with its policies to promote rupee trade settlement, are indicative of a strategic effort to position the rupee as a viable alternative in the global financial arena.

The journey towards the internationalization of the rupee is a testament to India’s evolving economic landscape and the proactive measures undertaken by the RBI. The central bank’s efforts to manage exchange rate fluctuations and promote the use of the rupee in international trade are crucial for enhancing India’s economic resilience. As the rupee gains acceptance globally, it will not only reduce currency risk for Indian enterprises but also contribute to a more stable and diversified global financial system. The RBI’s strategic maneuvers, therefore, represent a significant step towards realizing the vision of a globally integrated Indian economy.

In conclusion, the Indian rupee’s stability and the RBI’s strategic initiatives underscore the importance of strong economic fundamentals and proactive policymaking. Governor Shaktikanta Das’s assertion that the rupee is not artificially supported but rather a reflection of India’s robust economic foundations is a testament to the country’s economic resilience. The internationalization of the rupee, facilitated by measures such as the rupee settlement mechanism and local currency trade agreements, represents a significant milestone in India’s economic journey. While challenges remain, the RBI’s cautious and strategic approach ensures that the process of liberalization is balanced with the need for financial stability, paving the way for a more integrated and resilient global financial system.

The future of the Indian rupee on the international stage looks promising, thanks to the concerted efforts of the RBI and the Indian government. By reducing reliance on the US dollar and promoting the use of the rupee in international trade, India is positioning itself as a key player in the global financial system. The gradual and measured approach towards capital account convertibility, coupled with the promotion of rupee trade settlement, reflects a strategic vision aimed at enhancing economic resilience and stability. As the rupee continues to gain acceptance globally, it will play a pivotal role in shaping the future of international trade and finance, contributing to a more diversified and stable global economy.