Can Indian Rupee Make Its Way Into The International Monetary Fund’s SDR?

The International Monetary Fund is going to have its annual meeting this week. The meeting comes at a time when many have argued that the US Dollar’s hegemony is over, and that the global order is about to shift. Similar statements were made in 2008 after the North-Atlantic Financial Crisis. However, the dollar continues to be considered as a safe asset to hold.

As global trade expanded, the supply of two key reserve assets — gold and the USD — were insufficient and consequently, the International Monetary Fund created an international type of monetary reserve currency in 1969 referred to as Special Drawing Rights (SDR).

Special Drawing Rights are basically claims to a currency held by IMF member countries. These claims or SDRs may be exchanged or used in lieu of reserves etc. That is, a country has a right over an amount of a currency and the country can draw this amount from the International Monetary Fund to supplement their reserves.

For instance, if Brazil is short of USD then it can supplement its reserves using the SDR allotted to it. Typically, the SDR includes most widely traded currencies.

In 2016, the Chinese RMB was added to the list of currencies on the SDR, a feat that only select currencies such as the US dollar, Euro, Japanese Yen and Pound Sterling had till before.

The inclusion of China happened despite it being not freely convertible due to capital controls.

However, it was inevitable as China accounted for 15 per cent of the global output. This makes the Chinese Yuan a widely traded currency which further strengthened its case for inclusion in the SDR.

However, international adoption continues to be limited as restrictions on cross-border flows continue and we’re yet to see a serious deepening and widening of China’s financial markets.

This fact is why the Yuan is unlikely to emerge as the dominant global currency anytime in the near future.

One of the reasons why such an inclusion is beneficial is that it allows for a greater amount of bilateral trade to be settled in domestic currency.

Many have often argued that India’s rupee’s way to SDR is inevitable.

However, this in itself depends on us registering a strong economic growth that increases our share of world output. Further, we may also have to revisit the issue of capital account convertibility.

Indeed, full convertibility could bring with itself higher volatility, an increased burden on foreign debt and an effect on balance of trade (especially exports). However, it will also mean liquidity in financial markets and closer ties which augment employment in the non-farm sector.

More importantly, it will provide easy access to capital and help lower the cost of borrowings for Indian firms. A calculated move towards full convertibility is inevitable as India’s trade share increases over time. However, whether we bite the bullet and have a full convertibility or just stop short of it is anybody’s guess now.

Indeed, India will invariably have its rupee as a part of the SDR and there the rupee perhaps stands a better chance as being widely accepted compared to the Yuan. However, achieving the same won’t be easy as we will have to do a rethink on multiple fronts.

First would be on reforms that can unshackle our manufacturing sector. Covid – 19 disruption can accelerate this process provided we set in place an agile, dynamic executive institution that can reorient supply chains in favour of India.

The peninsular regions will be major beneficiaries of this in the short run but the landlocked areas too will benefit over the coming years from such a transformation.

It is only when Indian goods are a major part of global trade that we can expect our rupee to have such an influence.

The second rethink will be on trade, where we need to recognise that the regime of globalisation is over, now trade will happen through trade blocks and we must participate in some of the trade blocks that the US, UK and EU organise.

The only trade blocks that must be a strict no-go for India should be the ones with China in them.

The third rethink is on financial markets, especially on capital controls.

Now would be the time to systematically relax restrictions on foreign capital and put in place a more conducive taxation policy for taxes on capital, irrespective of whether it is foreign or Indian. Investments in India, either Foreign Portfolio Investment or Foreign Institutional Investment or Foreign Direct Investment should be as simple as opening a bank account on SBI’s YONO APP.

That is the standard that we should try to achieve over the coming months to emerge as an investor-friendly destination.

India’s strong financial sector which is very transparent combined with a rules-based regime makes it a much better contender than China to be used widely as a global currency.

However, getting there will take significant time and a lot of policy reforms over the coming decade. The first step, however, would be to get the rupee included in the SDR.