The Reserve Bank of India decision to permit rupee convertibility in exports and imports is a precursor to making the rupee an international currency. Although the convertibility is limited to the current account, the decision demonstrates India’s readiness to move forward toward full convertibility.

The essence of rupee convertibility is a challenge to the global economy of India’s strong macroeconomic fundamentals. A sharp bounce back in the economy, with GDP pitching 8 percent growth in 2022-23, after a fall by 7 percent in 2021-22, excels Chinese growth, which is forecast at 4 percent over the same period.  

The rupee played the role of a paradox in the currency market. While it dipped against the US dollar, it appreciated against other major currencies. Between February–June 2022, the rupee fell by over 4 percent against the US dollar. In contrast, it appreciated by 2.8 percent against the euro, 10.4 percent against the yen and 3.3 percent against the pound sterling. 

This ensures that strong macroeconomic fundamentals insulate the rupee. In other words, the fall of the rupee was not due to the weak health of the economy . Flight of capital by US investors in FPI due to high interest rate by the federal bank led the rupee's slide against dollar.

De-dollarization

De-dollarization has emerged a new wave in global trade. It was alleged that the US was weaponizing the dollar to exert influence in the world political landscape.  The imposition of sanctions and exclusion of SWIFT (Society for Worldwide Interbank Financial Telecommunication) triggered the wave. Currently, 70 percent of global trade is routed through the US dollar and 60 percent of the world foreign exchange reserve is stacked in US dollar.

De-dollarization is a challenge against US dominance in currency-led influence. The Chinese have argued that the US dollar gives disproportionate power to exert influence in the global economy. Eventually, the power of the US dollar has been used to dump the economy of US unfriendly countries. Chinese media Xinhua jeered that the US financial hegemony backfires as countries opt for de-dollarization.

As a result, the share of the US dollar in global foreign exchange reserves tapered. IMF economist Desmond Lachman has written: “The share of US dollar assets among foreign exchange reserves has dropped a 25-year low.”
  
Russia, China act

The fall of the US dollar's significance led countries like China and Russia to adopt alternatives to the dollar. China pressed trade partners, including Russia, to denominate some trade in RMB (renminbi – Chinese currency). It established an RMB trading centre in Hong Kong, Singapore and in Europe and created cross border stock exchange connection programme that denominate some trade and investment in RMB. In 2016, IMF included RMB in IMF SDRs (Special Drawing Rights), with China emerging an important global trading partner.

Following suit, Russia accelerated the de-dollarization move in 2014 when the US imposed sanctions on Russia for annexing Crimea in Ukraine. 

First, the central bank of Russia cut its reserves of US dollar by more than half between 2013 and 2020. Second, Russia held several discussions with China, India, Turkey and members of the Eurasian Economic Union (Armenia, Belarus, Kazakhstan and Kyrgyzstan) to give preference for trade in national currencies. In Q4 2020, Russian exports to BRICS, invoiced in US dollar, declined to 10 percent in 2020 from 95 percent in 2013.

Russia developed its own financial transfer system SPFS (System for Transfer of Financial Messages) – to allow US allies to pay for oil and gas in rouble after the US called for Russian banks to be disconnected from SWIFT.

Indian rupee 

An analysis says that the convertible rupee can gain strength at the behest of de-dollarization. As China – one of the top two trading partners of India - is tending towards de-dollarization and Russia is emerging a major crude oil supplier after the current oil shock, the de-dollarization wave leverages new opportunities for the rupee to be stronger.  

A number of benefits can be derived from rupee convertibility. First, the internationalization of the rupee will accelerate exports. Exports become more profitable. This is because as the rupee rate will be decided by the market foreign exchange rate and not by government intervention, the market rate is generally higher than the official exchange rate fixed. Given these, exporters can get more rupees than foreign exchange, for example US dollar, fixed officially before.  

Second, rupee invoicing in trade will insulate foreign exchange risks. Import of crude oil is a case in point. Currently, almost the entire import oil is transacted in US dollar. A surge in oil import is due to unprecedented rise in oil prices as well as fluctuation in the US dollar. In 2021-22, India’s import of crude oil increased by 93.5 percent in value term. But in quantity, it increased merely by 7.8 percent.

Third, it will provide incentives to NRIs to go for remittances. Eventually, it helps in increasing foreign exchange reserves.

Full convertibility

Days are ahead when the rupee will tend to be fully convertible. Full convertibility means fully capital account convertibility in the balance of payment. It opens the market for foreign investors, businessmen and trade partners. It encourages FDI flow and free flow of capital. Local businesses will have easy access to the foreign capital market for loans comparatively at lower rates.
 
Nevertheless, there is a catch. The rupee can be eclipsed by global volatility in the currency market.  It may also push up foreign debt.          

(The writer is a former Adviser, Japan External Trade Organization, New Delhi. Views are personal.)