China, whose dollar reserves have touched $2 trillion, is making noises about the ideal qualities of a reserve currency, in effect questioning the dollar’s future. This issue may look like something beyond India’s geo-economic reach. But that’s being unfair to India’s future. India can be a player in the global reserve currency game. The rupee need not always be a second rung currency. The Percy Mistry Committee had forecast that by 2020, the six most important currencies of the world could be the dollar, euro, sterling, yen, remnimbi and rupee. 2020 is just over a decade away. What might India have to do for its currency to join the global elite? There are two requirements. The first is high and continuous GDP growth. The blip in growth from the financial crisis will have to be just a blip. If India grows at 8% and above for the next ten years, the rupee will be a very strong contender as a reserve currency. The economy’s size as a result of such high growth and India’s political reputation as a stable democracy will give the currency the heft. Obviously, therefore, political commitment to high growth and therefore big policy changes and institutional reform is paramount. Politicians, who love to see the rupee strong, are the key to the currency’s future.
The second condition is a high quality central bank. The rest of the world will only trust a currency when a sound institutional structure envelopes the printing press where that currency is minted. Such a central bank will have political independence for the narrow function of monetary policy, full transparency of goals and instruments, accountability for achieving an inflation target in the medium term, and a top quality management team. RBI is some way away from this state of affairs. The rupee as a reserve currency issue makes it very clear that especially if India grows fast and over a long period, RBI has to be reformed. A country’s advantages of having a reserve currency go beyond other central banks investing in its short-dated bonds. This fiscal gain aside, since reserves make up the bulk of the portfolios of fixed income investors worldwide, considerable private investment goes into those currencies. Therefore, abundant cheap financing comes to governments and companies of privileged countries whose currencies have that special status. The toll required of an eight-lane expressway is lower because the cost of financing is lower because there is an abundance of investors who want to buy bonds denominated in the reserve currencies. Further, these governments and companies are able to avoid currency mismatches because they borrow in their own currencies. That’s a long list of advantages and should motivate India’s establishment.