The Indian Rupee and the SDR

Economics, Premium POM

By JC Collins

For the last ten years India has been working towards full capital convertibility.  But like China, this process takes a long time and must be coordinated with broader and deeper monetary adjustments.  Change to the domestic financial system is one of the more important aspects of this transformation and requires deeper credit markets than currently exists in India.

There is no doubt that India is on the threshold of major changes.  It is expected that the explosion of infrastructure development which took place in China over the last 15 years can be replicated in the world’s next most populous nation.

In fact, both monetary authorities and industry leaders from India have been strategically attempting to position themselves to capitalize on this forthcoming boom.  The transition from emerging/developing nation into a fully developed nation will be one of the driving indicators for international liquidity in the coming years.

Indian corporations such as Tata have been accumulating assets and preparing for the large demand which the next commodities boom will spark.  Feed lines from iron/ore deposits and other minerals have been established well in advance.

Like China having its currency included in the Special Drawing Right of the IMF, India would like to see the rupee included as well.  Consideration to international liquidity must be given to the rise and inclusion of any domestic currency.  Though India’s exchange rate management has been constructive and open, there are broader international demands which must be met.

Renminbi liquidity markets are only now beginning to develop and will require a careful balance between USD liquidity and RMB liquidity.  The swaying of global liquidity will need to be managed to ensure that gaps and losses are minimized so that growth can resume and a moderate level of inflation can ensue.

Throwing another currency into the SDR transition at this time would be premature.  The next SDR review would give more time for India to further develop its domestic capital markets and allow for the swell of renminbi liquidity to settle down.

India can in fact capitalize on the growing RMB liquidity by using that capital to fund domestic infrastructure projects and deepen domestic credit markets in the same manner which China used the US dollar as liquidity to complete massive infrastructure projects and develop the domestic yuan credit markets.

The concern with this process is the potential for a rupee credit bubble to develop in the same manner that a renminbi credit bubble developed in China.  This can be managed with clear strategies on monetary reform and exchange rate management directed towards rebalancing wealth between emerging and developed nations, which is one of the functions of using the SDR over domestic currencies in matters surrounding reserve requirements.

The demand for SDR inclusion will increase in the coming years as nations as diverse as Canada, Russia, Australia, and perhaps even Saudi Arabia, make the case to have each of their own domestic currency included in future weightings.

The road to a full international currency which functions on the weightings of a wide diversification of domestic currencies will be long and twisting.  Some nations will fail in their attempts while others will rise and meet the global expectations which are now being established with China’s transformation from a trade exporting economy to a financial services economy.

India has built up huge reserves and can position itself well in the coming years for SDR inclusion.  It is something worth keeping our eyes on as it will mean another large shift in the world economic structure.  – JC