India’s agreement with the United Arab Emirates (UAE) to trade in local currencies is the second big step towards internationalising the rupee. Russia last year agreed to sell crude oil to India in rupees after the West imposed sanctions on settlement in dollars. India is beginning at the top with the UAE, its third-largest trading partner after the US and China. And it has moved fast in a world that is trying to de-dollarise international payments where the yuan has not emerged as a serious contender for reserve currency. India needs to make the rupee more acceptable as it tries to bring its trade performance on a par with its growing heft in the global economy. A key facilitator is rupee trade that cushions exporters against exchange-rate risks.
The other reason the rupee needs to gain currency is India’s mounting current account deficit (CAD). Unlike other emerging Asian economies, India has not pursued export-led growth. Unless the rupee makes its way into the basket of tradable currencies, India’s rapid growth will work to strengthen hard currencies. This could crimp India’s potential growth rate. The rupee has a long journey ahead before it can aspire to become truly international. But the benefits outweigh the costs, and local currency trade, wherever possible, is the low-hanging fruit. The short-term impact of rupee trade on exchange and interest rates is more than offset by the progressive lowering of the cost of capital.
The tougher leg of the rupee’s globalisation has to do with capital controls. These are more difficult to remove than trade barriers at India’s stage of development. Typically, current account liberalisation precedes freeing the capital account. But India has become more protectionist in trade while nursing export ambitions. If manufacturing exports do not perform to the government’s lofty projections – and recent history provides little room for optimism – there could be grave impediments to relaxing capital outflows.
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