Can The Indian Rupee Overtake The US Dollar As A Global Reserve Currency?

Today’s globalised world has increased connections in almost every way. The one currency binding this globalisation on the international level is the United States Dollar or US Dollar. The currency has been under informal domination for a long time. However, its power explicitly increased after the fall of the Bretton Woods system 1971¹. Understanding this status of global reserve currency, carried by the US Dollar, is of utmost significance to understanding the global money exchange system.

Moreover, growing efforts towards spreading the global reach of the Indian rupee is a bright spot for the Indian economy. There are several benefits of it. Let us explore the US dollar's domination as a global currency and the Indian rupee's internationalisation.

The Dominance Of The US Dollar

Today, almost all countries express their exchange rates in US dollars, which indicates its dominance of the global exchange rate. Here are some crucial factors driving this domination of the US dollar:

• Economic Size and Stability: The United States boasts to be the world's largest economy based on its highest nominal GDP of 28.65 trillion US Dollars as of August 29, 2024². The stability and strength of the U.S. economy, along with the established rule of law and well-developed financial markets, have instilled confidence in the USD as a safe and reliable store of value.
• Financial And Trade Dominance: The US financial system, including its central bank and major financial institutions, plays a pivotal role in global finance. The country's dominance in international trade, backed by a robust network of multinational corporations, gives rise to widespread demand for the USD for transactions and settlements.
• Petrodollar System: Since the 1970s, the USD has been closely tied to the global oil trade. The agreement between the United States and Saudi Arabia, known as the Petrodollar system, established that oil would be traded primarily in USD. As a result, countries around the world need to hold a significant portion of their foreign exchange reserves in USD to facilitate oil purchases.
• Liquidity And Accessibility: The USD is highly liquid and widely available in financial markets around the world. It serves as the primary currency for foreign exchange transactions and is readily convertible into other currencies. This liquidity and accessibility make it a preferred choice for central banks and businesses to conduct international transactions.
• Historical Precedent: The USD's status as a global reserve currency has been in place since the end of World War II when the Bretton Woods system was established. Under this system, the USD was pegged to gold, and other currencies were tied to the USD. Although the system collapsed in 1971, the USD's role as a global reserve currency persisted and solidified over time.

Is The World Ready For A New Global Currency?

In recent years, since the 2008 financial market crash, the world has realised its reliance on US Dollar. The fear of growing dominance with the help of USD is setting in among the developing countries in the world. However, the world is growing multipolar and international trade is a crucial aspect of it.

The recent episode of US sanctions on Russia after it invaded Ukraine in early 2022, highlighted the need for a new global currency³. Global efforts from associations like BRICS (Brazil, Russia India, China, and South Africa) to introduce a new currency system for global trade is a strong indicator of how countries are bracing trying to ‘De-Dollarize’ their economies.

The Indian economy has been in the bright spot for the past few years. However, the Indian currency exchange rate is a concern. Therefore, India is also gradually building its resilience to US dollar dependence.

Key Milestones In The Globalization Of The Indian Currency

India is one of the strongest growing countries in the world with 6.8% real GDP growth despite the exploding population, as of April 2024, which is a remarkable feat⁴. In the past few years, India’s contribution to the global economy has been highlighted. Moreover, its resilience in pandemic times and innovation are its crucial driving factors. 

Indian currency rate today, as of September 12, 2024, is INR 83.98 for 1 USD⁵. However, the Indian currency exchange rate has been an ever-present matter of concern. Fluctuations in the exchange rate heavily affect the trade and overall money supply for the Indian rupee.

To combat the fluctuating Indian currency rate, the country is gradually in the process of internationalisation of the Indian rupee. Some of the crucial steps taken in this direction are discussed here.

1. Inter-Bank Vostro Account

During the saga of sanctions on Russia by the US, the Reserve Bank of India allowed invoicing and payments in Indian Rupee in February 2023⁶. Such trades are facilitated by a Special Rupee Vostro Account (SRVA). Vostro account is the facility to transact with overseas bank accounts in the domestic currency. Moreover, countries like Russia also find it easy to transact due to the lower denomination of Indian rupee against their currency.

The main benefit of this system is that the cost of exchange of intermediaries is eliminated. SRVA is in Indian currency and in India. If India is in a transaction with Russia, then its currency would be deposited in the Vostro account in India and it will be then converted to Indian Rupee.

This settlement process even attracted other countries. As of August 2024, 22 countries are allowed to open the facility of Vostro accounts by the RBI. It includes Israel, Germany, Belarus, Fiji, etc⁷.

2. Indian Foreign Exchange Reserve

The assets held by RBI in the denomination of foreign currencies are known as the foreign exchange for the country. It reached the record mark of USD 32.9 billion as of May 17, 2024. This signifies India’s resilience to ongoing geopolitical tensions and strong financial position.

Moreover, recently Indian government bonds were included in the JP Morgan Government Bond Index- Emerging Markets (GBI-EM) on June 28, 2024⁸. This inclusion is crucial for capital flow in the country. Moreover, it can improve the overall standing of Indian financial securities.

3. Indian UPI system

The Indian marvel of Unified Payment Interface (UPI) has revolutionised the digitalisation of finance in India. As of August 2024, the value of UPI transactions in the country reached a massive mark of INR 20,60,735 crores⁹. This growth is not just limited to India. As of August 2024, it spanned 7 crucial countries in the world like Mauritius, Singapore, United Arab Emirates, etc. This reach is instilling confidence in the Indian currency.

4. BRICS Initiative

The international organisation of BRICS is the classic representation of some of the fastest emerging countries in the world. China’s Yuan market share reached the historic mark of 43% market share in international payments¹⁰. However, its global presence remains limited. Moreover, the countries in this organisation are working aggressively toward internationalisation of their currencies.

These countries have some bilateral and multilateral trade agreements between them. However, reports suggest that BRICS nations are planning a ‘new global reserve currency’. It would affect the Indian rupee's internationalisation significantly.

Why Internationalisation Of The Indian Rupee Matters

In the journey towards becoming a developed country, India needs to conquer many challenges. One of them is strengthening the Indian currency. Some of the prominent benefits of the internationalisation of the Indian rupee are:

• It will improve the monetary standing of the country, catalyse the money supply and offer flexibility in international functioning.
• Reducing dependency on foreign currencies like the US dollar will safeguard the currency from excessive inflation and benefit international trade.
• A significant cost of conversion can be potentially reduced or eliminated with internationalisation.
• The Indian financial system can experience unprecedented growth, which will drive overall benefit to the citizens of the nation.
• It will strengthen the overall positioning of India in the global economy. 

The Future Of The Indian Rupee: What Lies Ahead?

India’s aspiration towards internationalising the Indian rupee is a long journey rather than a single destination. Indian finance has yet many flaws and without finding their solutions, the journey would be incomplete. Issues like growing populations, income inequality, exchange rate volatility, strict regulations, etc., should be focused on to pave the path for a bright future for the Indian rupee.

We need to modernise India’s financial system, strengthen regulations and reduce barriers to international capital flows, diversify its economy and increase access to capital for businesses, and create a strong infrastructure for digital payments.

Here are some reforms that can help in catalysing the current reforms for the future of Indian rupee:

• Encourage and incentivise international trade stakeholders like importers/exporters to trade in the Indian rupee. If countries start to buy the Indian rupee, due to demand-supply, it would appreciate.
• Establishing efficient and encouraging tax structure for the same.
• Feasible conversion reforms for the Indian rupee.

Final Thoughts

The US dollar has been a prominent global currency for a substantial time and it has a strong hold over its overall management. Therefore, replacing the US Dollar on the international level will not be an easy path. It would require heavy reforms. However, India’s current steps towards internationalising the Indian currency are appreciable. The Indian rupee has the potential to show progress in the upcoming period with appropriate steps in that direction. To learn more about the economy and markets sign up on Grip Invest today.

 References

1. International Monetary Fund, Accessed from: https://www.imf.org/external/about/histend.htm#:~:text=End%20of%20Bretton%20Woods%20system,-The%20system%20dissolved&text=In%20August%201971%2C%20U.S.%20President,the%20breakdown%20of%20the%20system.
2. FRED Economic Data, Accessed from: https://fred.stlouisfed.org/series/GDP
3. S&P Global, Accessed from: https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/sanctions-against-russia-8211-a-timeline-69602559
4. International Monetary Fund, Accessed from: https://www.imf.org/external/datamapper/profile/IND
5. Yahoo Finance, Accessed from: https://finance.yahoo.com/quote/INR%3DX/history/?guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAABBe0OeWKi4o76AjIox3ruNq6ZCtkvaee7cYo6EPOr-PIh7ZnNGVGOhAFRtcuBLljwtr-91dkIsN80CGJc69UH5o1LuEn_2nq1qB67Ho-Aw0_kKNdTne126kIHEPRM9UvdU9zcwpWiC27MSNDnpcyFpYPPrrjMR0XMSdUMmXeHhF&guccounter=2
6. Ministry of finance, Accessed from: https://www.pib.gov.in/PressReleasePage.aspx?PRID=1896727
7. The Economic Times, Accessed from: https://economictimes.indiatimes.com/industry/banking/finance/banking/rbi-permits-banks-to-open-vostro-accounts-from-22-countries-for-trade-in-rupee/articleshow/102144580.cms?from=mdr
8. Mint, Accessed from: https://www.livemint.com/market/stock-market-news/jp-morgan-bond-index-india-inclusion-this-week-explained-key-changes-flows-impact-on-yields-what-should-investors-do-11719388118238.html
9. NPCI, Accessed from: https://www.npci.org.in/what-we-do/upi/product-statistics
10. Goldman Sachs, Accessed from: https://www.goldmansachs.com/insights/articles/chinas-currency-rises-in-cross-border-trade-but-remains-limited-globally

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