Dollar Today, Rupee Tomorrow

Source: The post is based on the article “Dollar Today, Rupee Tomorrow” published in The Times of India on 21st August 2023.

Syllabus: GS 3 – Indian economy – Money and Currency

News: In this article author discusses the challenges and implications of making the Indian rupee an international currency, comparing it to dominant currencies like the U.S. dollar. They argue that India should focus on economic growth and trade expansion, rather than rushing to internationalize the rupee.

What are the functions of a currency such as the rupee?

The functions of a currency like the rupee are:

Medium of Exchange: Used to buy and sell products within India.

Unit of Account: Prices of products are set in rupees.

Store of Value: People save and hold rupees for future use.

Example: When both a buyer and seller in India transact, they use the rupee for payment and set the product’s price in rupees.

What is the role of international currencies?

The role of international currencies includes:

Medium of Exchange: Used for global trade between different countries.

Example: Over 80% of global trade transactions between 1999 and 2019 used the U.S. dollar.

Unit of Account: Sets prices for international transactions.

Example: Most world trade prices are in dollars or euros.

Store of Value: Held by central banks as reserves.

Example: Central banks hold 60% of their reserves in the U.S. dollar.

Dominance in Finance: 60% of international banking deposits and loans are in dollars.

What are the challenges of making the Indian rupee an international currency?

Small World Trade Share: India contributes less than 2.5% to global merchandise trade and less than 4% to world services trade. Most transactions use the dollar.

Limited Financial Transactions: India’s global financial transaction share is even smaller. Its corporate bond market is young, and public banks dominate.

Lack of Full Convertibility: India hasn’t fully adopted capital account convertibility, limiting the rupee’s use in global financial transactions.

Foreign Exchange Reserves: The Reserve Bank of India holds about $600 billion in foreign currencies, primarily for rupee stability. Other countries might not store large rupee reserves.

What should be done?

Focus on Growth: Prioritize expanding the economy, trade, and foreign investment.

Avoid Premature Changes: Don’t rush to make the rupee fully convertible just to speed up its internationalization.

Natural Progression: Let rupee internationalization follow as India’s economic stature grows.

Prioritize Stability: Ensure the rupee’s stability without compromising major objectives.