Indian Rupee As A Regional Hegemon - A Realistic Possibility Or A Far Fetched Dream:- Economic Analysis

Courtesy :- Marketcalls

Introduction -

Indian Rupee has been at a center of debate for many years now. The Indian rupee is the official currency of the fourth largest economy of the world. Indian rupee represents a history of monetary policy and fiscal policy reforms. For many of the starters, Indian rupee as a currency came into existence in the early 16th century and since then has undergone many changes. Today, the rupee stands at an interesting juncture where the Narendra Modi government is looking to internationalise the rupee through interesting means like the UPI, opening of vostro accounts in Russian banks etc. can the efforts of seeing the INR as a regional hegemon a realistic possibility or is it a far fetched imagination, is what the article tries to analyse today.

Confidence behind rupee internationalisation decisions -

Internalisation of the rupee has been a constant chatter in the monetary and fiscal policy of circles since the coronavirus pandemic, where the Indian economy showed massive economic resilience by lodging growth rates which have helped it to be the world's fastest economy since the past 5-6 years.

Even, during the past 4 years, since the start of the Russia - Ukraine war, which has crippled major european economies, including EU, whose overall growth rate for Q2 of FY 2025 was as low as 1.4%, India has maintained an average growth rate of 7.2% which shows that the Indian domestic demand, exports amongst the reform oriented policies are actually helping the economy emerge from the shadows. This is a smart step as India's merchandise trade has constantly increased 

Another reason, why this growth rate becomes important is because, over the past 4 years, the South Asian region has been a geopolitical pandora box. The major changes in this region have been:- Brutal coronavirus pandemic, Taliban takeover of Afghanistan which occured in 2021, Pakistan's ever volatile domestic policies and the dictatorial ironclad policies of the millitary, Sri Lanka's economic crisis which overthrew the Rajpaksha brothers, Nepal deposing off the entire political system dominated by the Communists & Nepal Congress, Bangladesh seeing anti Awami League protests along with the installation of an "interim" PM Md. Yunus by the West who is hestitant in conducting elections, India's successful Operation Sindoor against Pakistan post the Pahalgam terrorist attacks have been some of the events that could have shocked even the world's most resilient economies and India itself has seen many motivated protests.

In the backdrop of so many protests, India maintaining strong growth rate should be rated by the economists as the "21st century miracle".

Hence, the growth that India has recorded over the past 4 years is the credit to major reforms that the country has consistently seen since the 1990s and more specifically post the 2016 demonetisation. Factors like smart monetary policies of the RBI, political stability in India, strong international exports, near elimination of absolute poverty from the country etc. have aided this growth journey. This is the prime reason why the Government of India & RBI are confident enough that now is the right time to internationalise the rupee. The 2 graphs below show about India's external sector in detail.

Source: BIS

 

Source  : BIS

Open Macro logic-

The RBI has taken massive steps in this regard to internationalise the INR over the past few years. One of the steps taken is to increase the rupee invoicing by the exporters. Invoicing in currency is a central force for the trading patterns noticed in the country. The invoicing framework system in open macroeconomics has multiple core intuitions.

Trade prices are set up in 3 broad ways, namely :- Producer currency pricing where an exporter invoices in its own currency. Exchange rate movements affect foreign prices, more than exporter revenues. This tactic or startegy though is rare as to be a PCP country, financial deepening, credible currencies & strongman geopolitical startegies are required. Hence this mechanism is used majorly by countries like - Japan, USA, Switzerland amongst others. 

Local currency pricing where the exporter invoices in importer's currency, where exchange rate movements affect exporter revenues over foreign prices. This is a tactic leading to low exchange rate pass through to import prices and muted expenditure. This mechanism is used majorly by countries like Canada & Australia. 

The third mechanism is Dominant currency pricing, most global trade is invoiced in third currency mainly USD today. The reason countries do so, is because it helps in minimising transaction costs, hedging constraints & pricing risk, which in turn causes exchange rate movements of non dominant currencies to have weak effects on trade volumes, but has strong effects on domestic inflation. Hence, the cost of any country importing inflation in a DCP mechanism, especially in the backdrop of geopolitical tensions or interest rate changes is quite real and does not help in insulating the economy. This can be considered as a reason why developing countries over the decades have adopted a DCP mechanism and have seen usually high inflation rates in period of high growth rates.

As. T.Rabi Shankar, pointed out in one of the BISs research, internationalising the rupee would help reduce dependence on foreign exchange reserves & project external stability. He noted in his speech, that, forex reserves of a country using DCP mechanism is borrowed funds. Banks and corporate incur external debt at market rates which are then invested in Government securities issued by advanced economies (AEs). The rate at which external debt is incurred issubstantially higher than the return on reserves. 

In layman's language, India is trying to move from the third mechanism to the first mechanism, by takingh many interesting steps.

Steps for rupee as an international currency -

Vision IAS

The RBI in this regard has taken serious steps over the past 4 years to make rupee as an international currency, as the one factor that keeps away exporters from going away from DCP to PCP is committment based monetary policy that the RBI has adopted ever since the pandemic. The one logical step is, rupee denominated trade settlement where exports have been facilitated in INR.

This has been facilitated even in by easing FEMA regulations when Open INR accounts have been launched for settling all transactions with Indian residents in abroad branches of authorised banks, this is for foreigners. Any NRI also can open their account in special vostro account, on which an excellent explanation can be found here. 

The second step, taken by the RBI & GoI is to expand the reach of UPI services in multiple countries. Today, UPI is a payment mechanism which obviously covers 40%  of the world's digital transactions per minute, but this has been expanded in countries like :- UAE, Singapore, Bhutan, Sri Lanka, France & Mauritius. The rollout does help in expanding the reach of INR in terms of invoicing and maybe even in attracting FIIs but does not help the cause of making INR a regional hegemon, as there needs to be an integration with the financial markets of these countries, which India is currently lacking.

RBI has signed MoUs with other central banks to promote local currency settlement, including rupee. Trade agreements with partners like Sri Lanka designate INR as a foreign currency. Cross border lending in INR has also started.The RBI’s Strategic Action Plan 2024–25 includes allowing persons resident outside India (PROI) to open INR accounts abroad.

All these steps can be considered as baby steps which the RBI has undertaken so far and since the decisions have barely come into force a few years ago, not a lot of analysis can be realistically done in this regard.

Future roadmap -

The success of these steps by the RBI, depend upon a host of factors which not a lot of economists have explicitly mentioned about in the past. The first factor or maybe, risk is that, as noted by T. Rabi Shankar in his speech at BIS in 2022, that India is capital deficient country & needs foreign capital to fund its growth, at this time making rupee as an international currency can be a risk which ends up losing foreign capital. The reason being so, is that, external shocks can become very prudent on the INR and the RBI would need a separate focus wing to stabilise the INR in such circumstances.

The core of this problem is that India is a labor surplus country, while being short on capital, the only possible step in this case is to do 2 things simultaneously - (1) Capital expenditure by the GoI must be increased to around 15 lakh crore in FY 2026 and bring in policies which promotes capital heavy industries & goods like rare earths, semiconductors, AI amongst others. Furthermore, private capital must step in to increase the domestic capital market (2) India must also try to attract massive FDIs in capital intensive industries which generate employment, given the labor surplus in the country, the states can very well absorb the educated youngsters into these capital intensive industries which should set up shop in the country. Furthermore, Startup India & Standup India schemes should promote capital intensive businesses and startups. The reason, why capital intensivity of a country is critical can be found in the economic growth of China, only country which can be compared to Indian economy, had the majorly "failed" cultural revolution of 1960s but the home backyard steel production model, actually helped the country to launch their much famed 1978 reforms which really helped their economy.

The second, factor underrated but very critical in what decides a currency being a regional hegemon is, geopolitical muscle power & soft power. In the inter war years, where different currencies were ruling the roost in many different countries with their own areas of influence, the major reason was imperialism and the biggest benefactor of this was the UK, whose GB Pound Sterling was official currency of as many as 70 years, this helped them to borrow more from treasury bonds. The USA , though not an imperial power, followed the policy of "gunboat" diplomacy, which helped them maintain dollar supremacy in the fiscal markets of Latin America etc.

Now, India cant follow "gunboat" diplomacy, as the USA has done over the years, the main innovation can be done in the FTAs that India has been signing recently, the countries like Oman wanting a FTA with India, must be asked to do a portion of trade (preferably of the largest net trading commodity) in INR, which will increase the net inflows of INR into the country. This can be a start, however, India should also carry out massive defence reforms like - producing more fighter engine jets, stealth submarines, using Indian Navy as a diplomatic arm in troubled Indian waters, increasing nuclear warheads, fulfilling demands like Ahir Regiment/Bengal regiment more reforms like SHANTI bill are necessary in this field. India should also try to make the neighbourhood as its own political "backyard" both in terms of financial & non financial means.

Conclusion -

Later on, India should issue treasury bonds to countries with which India enjoys good relations, possible countries include - Russian Federation, Liechenstein, Afghanistan, Israel, Iran, Ethiopia, Brunei, Maldives, Mauritius, Seychelles, Cayman Islands, Fiji, Papua New Guinea, Saudi Arabia, UAE, Sri Lanka, Nepal, Bhutan, Phillipines & South Africa to name a few. India must also try  to attract FDIs from major countries like Singapore & UAE in INR, instead of US$ which would also allow for capital injection at a cheaper rates. Even timely completion of trade routes like IMEEC & INSTC can help the country massively in this area for India.

Finally, the policy of rupee internationalisation and making it as a regional hegemon currency in troubled geopolitical times, must not be a mere footnote and must be a constant policy decisions which also requires strong fiscal & monetary policy coordination, in which India enjoys a historic stronghold. If India, is indeed able to internationalise the rupee & make it even a regional hegemon, it would be considered as a massive comeback for a country which a decade ago launched demonetisation just to battle counterfeits in its economy.