The internationalization of Rupee or a situation in which the Rupee is used as a medium of exchange for international transactions is in the dream of most Indians. But the question whether and when the rupee will reach that coveted position need careful and realistic analysis.
Economic history shows instances for the emergence of few international currencies. The US Dollar has become an international currency by 1925 and the world has entered into a Dollar standard in 1944, with the signing of the Brettonwoods agreement. After 1972, few other currencies including the British Pound Sterling, Japanese Yen and the Euro have also emerged as international currencies.
Wide acceptance by investors and traders for trade and financial (investment) purposes makes a currency popular and thus a hard (international) currency.
A more recent development is the ongoing march of the Chinese Renminbi (yuan) towards the status of an international currency. It has accommodated under the IMF’s reserve currency basket. The renminbi’s achievement was rightly supported by the progress of the Chinese economy. Export oriented growth has made China a world trade power. Similarly, Beijing has designed agreements with partner countries to settle imports and exports payment in Renminbi. This has made its currency a popular one for settling trade transactions. In other words, China’s economic achievement has strengthened the popularization of the renminbi. The same has happened in the case of USA and to an extent for UK and Japan in the past.
Though the Chinese currency is reasonably accepted among traders, it is less popular among foreign investors. Foreign investors are not using Yuan as they use the Dollar. Here, to get the status of Dollar, China has to open up its financial sector. For example, most central banks keep their foreign exchange reserve in US Government bonds and treasury bills. This is because US issues large volume of bonds and allows other country central banks to buy it. US is such a large economy, issues huge volume of bonds and allows other central banks like the People Bank of China (PBC) to invest in US bonds and treasury bills. The PBC itself has nearly $4000 bn foreign exchange reserves and only a large economy like US can absorb this huge investment by offering Treasury bills and bonds.
For rupee to become the global currency, first stage is that it should make higher exports and imports so that the currency become a popularly tradeable currency. This need the economy to develop its industrial sector (using rupee to settle trade). Stable exchange rate and deep (high turnover) foreign exchange market are important to make rupee an international currency. There is no alternative for faster growth and industrialization. The strength and weakness of the economy is actually reflected in the strength and weaknesses of its currency.
Similarly, other central banks maintaining their foreign exchange reserves in rupee denominated assets like India government bonds also is decisive to make the rupee an international currency.
Looking at these requirements, it is easy to recognize that some conditions can be met through policy measures like conditioning the Indian foreign exchange market and financial markets. But other requirements need a long term progressive performance of the economy including competitive industrial sector, increase in trade share with other countries etc.
At present, the Indian Rupee is certainly far away from any meaningful internationalization. But in the medium term future, with enhanced economic development and trade expansion, the rupee can become an international currency. Size does matter and hence there is enough potential for rupee to become an international currency. China is the largest economy, US is the second largest and India is the third largest in the world. Internationalization of a currency can get tremendous energy from big economic size. One day, the Rupee will become a hard currency; but the question is how quick it will be.