India should become a middle-income country and then push to make INR (rupee) a hard currency, and till then, it must promote the settlement of global trade in the local currency, think tank GTRI said on Sunday.
Global Trade Research Initiative (GTRI) said that transforming a currency into a hard currency is a complex process that hinges on several pivotal factors.
Firstly, economic stability is paramount; a country must exhibit low and stable inflation, consistent growth, and a balanced trade environment.
This stability underpins confidence among international investors and trading partners, it added.
Equally crucial is the implementation of strong fiscal and monetary policies by the government and central bank, including effective national debt management and sensible interest rate policies, it said, adding aspiring for reserve currency status is a significant aspect.
This status is typically achieved when a currency is widely used and trusted, and reciprocally, it gains trust because of its widespread use.
Political stability also plays a critical role, as it reassures external entities of the nation's economic consistency, the think tank said.
Hard currencies are widely accepted around the world for international transactions and are considered a reliable and stable store of value.
The presence of a currency as a hard currency reflects perceived stability, reliability, and economic strength of its issuing country.
The US dollar is the most dominant hard currency, often considered the world's primary reserve currency.
It is used in a significant majority of international transactions and as a benchmark currency for most commodities.
"The process requires significant systemic changes, which could, potentially, destabilise India's economy.
"Therefore, it might be more prudent for India to wait until its economy grows further and reaches a middle-income status before aspiring to make the INR a hard currency.
"In the meantime, India should work to make local currency settlements more robust. This approach would allow the economy to stabilise and strengthen, making the transition smoother and less risky.
"Presently, conditions are not ripe for India pushing to make INR a hard currency," the Global Trade Research Initiative said.
Some of the most recognised hard currencies and their approximate global share in international transactions and reserves include US Dollar (60 per cent), Euro (20 per cent), Japanese Yen (5-6 per cent), British Pound Sterling (4-5per cent), Swiss Franc (1 per cent), Canadian Dollar (2-3 per cent) and Australian Dollar (2-3 per cent).
Currently, the rupee's international trade role is limited, especially when compared to established hard currencies like the US dollar, euro, or even the Chinese yuan, it said.
"A pivotal step in this transformation is making the rupee fully convertible on the capital account, a key trait of hard currencies.
"However, this move is fraught with complexities, primarily exposing the economy to volatile capital flows that can destabilise the currency," GTRI co-founder Ajay Srivastava said.
Another major hurdle, he said, is managing India's balance of payments, especially in reducing trade deficits.
Persistent trade deficits exert downward pressure on the rupee, undermining efforts towards currency stability.
Additionally, developing deep and liquid forex markets is critical to managing large-scale currency conversions without significantly impacting the rupee's value, Srivastava said, adding that this requires maintaining a fine balance in exchange rate management; excessive intervention or too little can lead to either artificial valuations or high volatility, respectively.
Reforming the financial system, encompassing banking and non-banking sectors, is also necessary, but poses risks of destabilisation during the transition, Srivastava said.
"Beyond policy changes, elevating the rupee to hard currency status demands a shift in international perception and confidence in India's economy and financial systems, a complex and prolonged process," he added.
Instead, he said, India should work to make local currency settlements of trade more robust.
In July 2022, the Reserve Bank of India introduced a system for settling international trade transactions in the Indian Rupee (INR).
According to the GTRI, the move was meant to aid countries in Africa and South Asia struggling with foreign exchange shortages caused by the post-Covid decline in exports and tourism and those affected by US sanctions.
However, the system has not been "very effective" because it requires converting foreign country currencies twice - first into US dollars and then into INR, the think tank said, adding that this double conversion results in a loss of 3-4 per cent of the transaction value, as these countries do not have direct exchange rates with the rupee, making the process less attractive.
Local currency trading would reduce transaction costs by eliminating the need to convert currencies twice.
For example, an Indian company importing machinery from Russia would currently need to buy dollars, incurring a premium, and then the Russian counterpart would convert these dollars into Russian Roubles, again incurring a conversion cost.
"Local currency trading would allow direct conversion between INR and Rouble, reducing these costs. To facilitate this, India needs to establish a transparent and open currency exchange," Srivastava said, adding this exchange would provide clear and market-determined exchange rates between local currencies like INR and other currencies such as the Russian Rouble, Malaysian Ringgit, Thai Baht, or Chinese Yuan.
He added that this would not only give banks a reliable reference for issuing letters of credit but also help businesses understand currency volatility better.
"Additionally, countries with currency surpluses, like Russia with its INR surplus from oil exports to India, could exchange their surplus for other currencies more efficiently in such a multi-currency exchange platform," he said.
