Central Idea

• The recent announcement by the Indian government regarding a long-term road map for the internationalization of the rupee holds immense potential for the country’s economic growth. This move aims to revive the rupee’s historical prominence as a widely accepted currency in the Gulf region and strengthen its position in the global foreign exchange market.

*Relevance of the topic*

The Indian government has been consistently focused on promoting the internationalization of the rupee.

India has been exploring the use of the rupee for bilateral trade settlements with its trading partners, for instance amidst Russian oil ban, India explored Rupee-Rubel settlement for oil imports.

China, Russia and a few other countries have become more vocal in questioning the US dollar-dominated global currency system

Historical Context

• Indian Rupee as Legal Tender in the Gulf Region: In the 1950s, the Indian rupee held the status of legal tender in several Gulf countries, including the United Arab Emirates, Kuwait, Bahrain, Oman, and Qatar. It was widely used for various transactions, and these Gulf monarchies purchased rupees using the pound sterling.
• Introduction of the Gulf Rupee: To tackle challenges related to gold smuggling, the Reserve Bank of India (Amendment) Act was enacted in 1959. This legislation led to the creation of the Gulf Rupee, which was intended for circulation only in the West Asian region. The central bank issued notes specific to the Gulf region, and individuals holding Indian currency were given a six-week window to exchange their rupees for the new Gulf rupee.
• Devaluation of Indian Rupee and Transition to Local Currencies: In 1966, India devalued its currency, which eventually had repercussions on the acceptance of the Gulf rupee. The devaluation eroded confidence in the stability of the Indian rupee, prompting some West Asian countries to replace the Gulf rupee with their own sovereign currencies. The introduction of sovereign currencies in the region was driven by both economic factors and concerns about the Indian rupee’s stability.
• Impact of Demonetisation: In 2016, the Indian government implemented a demonetisation exercise, which involved invalidating high-value currency notes, including the ₹1,000 and ₹500 denominations. This move aimed to curb black money, corruption, and counterfeit currency. However, it also had an impact on the confidence in the Indian rupee, both domestically and among neighboring countries such as Bhutan and Nepal.
• Withdrawal of ₹2,000 Note: In recent times, the decision to withdraw the ₹2,000 note from circulation has further affected confidence in the rupee. This move has led to concerns and uncertainties among the public and businesses, particularly regarding the stability and continuity of currency denominations.

What does it mean by Internationalizing the Indian Rupee?

• Internationalizing the Indian Rupee refers to the process of increasing the acceptance, use, and recognition of the Indian rupee as a global currency. It involves making the rupee more widely used and traded in international markets, increasing its convertibility, and promoting its adoption for cross-border transactions, trade settlements, and investment activities

Advantages of internationalization of the rupee

• Enhanced Trade and Investment: Internationalization of the rupee can facilitate smoother trade transactions between India and other countries. This can lead to increased bilateral trade, attract foreign investment, and boost economic growth.
• Reduced Exchange Rate Risks: Internationalisation reduces exchange rate risks associated with fluctuations in major global currencies. When the rupee becomes more widely accepted and used in international transactions, it reduces the vulnerability of the Indian economy to external currency volatility.
• Lower Transaction Costs: Greater international acceptance of the rupee can reduce transaction costs for businesses and individuals engaged in cross-border trade and remittances.
• Strengthening Financial Markets: A more internationalized rupee would lead to the development of deeper and more liquid rupee-denominated financial markets. This includes rupee bond markets and derivatives markets. It helps diversify funding sources and provide greater stability and opportunities for investors and businesses.
• Reserve Currency Status: The internationalisation of the rupee can potentially lead to its recognition as a reserve currency. Reserve currency status enhances a country’s monetary and financial influence globally and promotes stability in international financial systems.
• Boosting India’s Global Standing: Internationalisation of the rupee signals the country’s economic strength, reforms, and openness to international trade and investment. It can improve India’s reputation as an attractive investment destination and strengthen its role in regional and global economic decision-making forums.

The Challenge of International Demand for the rupee

• Low Daily Average Share: The daily average share of the rupee in the global foreign exchange market is approximately 1.6%. This indicates that the rupee is not extensively traded or widely used for international transactions compared to currencies like the US dollar or the euro.
• Limited International Transactions: Although India has taken steps to promote the internationalisation of the rupee, such as enabling external commercial borrowings in rupees and encouraging trade in rupees with select countries, the volume of such transactions is still limited. For instance, India continues to purchase oil from Russia in dollars, and efforts to settle trade in rupees with Russia have faced challenges.
• Capital Account Convertibility Constraints: India imposes significant constraints on capital account convertibility, which refers to the movement of local financial investments into foreign assets and vice versa. These restrictions are in place to mitigate risks of capital flight and exchange rate volatility, given India’s current and capital account deficits. However, they limit the ease of converting rupees into other currencies, reducing international demand.
• Lack of Reserve Currency Status: For a currency to be considered a reserve currency, it needs to be fully convertible, readily usable, and available in sufficient quantities. The rupee does not currently enjoy reserve currency status, and its limited convertibility and usage hinder its attractiveness for central banks and international institutions to hold significant amounts of rupees as part of their foreign exchange reserves.

Learning from China’s Experience

• Phased Approach: China adopted a phased approach to internationalise the Renminbi (RMB). It initially allowed the use of RMB outside China for current account transactions, such as commercial trade and interest payments, and gradually expanded it to select investment transactions. This gradual approach helped in managing risks and ensuring a smooth transition.
• Offshore Markets and Clearing Banks: China established offshore markets, such as the “Dim Sum” bond and offshore RMB bond market, which allowed financial institutions in Hong Kong to issue RMB-denominated bonds. Additionally, China permitted central banks, offshore clearing banks, and offshore participating banks to invest excess RMB in debt securities. These measures enhanced the RMB’s liquidity and facilitated its usage in international transactions.
• Currency Swap Agreements: China entered into currency swap agreements with several countries, including Brazil, the United Kingdom, Uzbekistan, and Thailand. These agreements enabled the exchange of equivalent amounts of money in different currencies, facilitating trade and investment transactions in RMB and reducing reliance on other currencies.
• Free Trade Zones: China launched the Shanghai Free Trade Zone, which facilitated free trading between non-resident onshore and offshore accounts. This zone provided a platform for international businesses to transact in RMB and boosted the currency’s international usage.
• Reserve Currency Status: China’s efforts towards internationalisation of the RMB led to its recognition as a reserve currency. By the second quarter of 2022, the RMB’s share of international reserves reached approximately 2.88%. This status further solidified the RMB’s acceptance and usage in global financial markets.

Way forward: Reforms for Rupee Internationalisation

• Full Convertibility: The rupee should be made more freely convertible, with a goal of achieving full convertibility by 2060. This would involve allowing financial investments to move freely between India and abroad, removing significant restrictions on currency exchange and capital flows.
• Deeper and More Liquid Rupee Bond Market: The Reserve Bank of India (RBI) should focus on developing a deeper and more liquid rupee bond market. This would enable foreign investors and Indian trade partners to have more investment options in rupees, enhancing the attractiveness and usage of the currency.
• Trade Settlement in Rupees: Indian exporters and importers should be encouraged to invoice their transactions in rupees. Optimising the trade settlement formalities for rupee import/export transactions would facilitate greater usage of the rupee in international trade, reducing reliance on foreign currencies.
• Currency Swap Agreements: India can establish additional currency swap agreements with trading partners. These agreements would allow India to settle trade and investment transactions in rupees, eliminating the need for reliance on reserve currencies like the US dollar.
• Tax Incentives for Foreign Businesses: The government can provide tax incentives to foreign businesses operating in India, encouraging them to utilize the rupee in their operations. This would boost the demand for the rupee and promote its usage in international transactions.
• Currency Management Stability: The RBI and the Ministry of Finance should ensure consistent and predictable issuance and retrieval of notes and coins, promoting currency management stability. This stability is crucial for building confidence in the rupee’s value and maintaining trust among market participants.
• Exchange Rate Regime Improvement: Improving the exchange rate regime by adopting transparent and market-based mechanisms can enhance the stability and credibility of the rupee’s exchange rate. This would instill confidence among investors and businesses dealing in rupee-denominated transactions.
• Higher Profile in International Organizations: Efforts should be made to push for making the rupee an official currency in international organizations. This would raise the profile and acceptability of the rupee globally, contributing to its internationalisation.
• Pursuing Expert Committee Recommendations: Recommendations from expert committees, such as the Tarapore Committees, should be pursued. These recommendations include reducing fiscal deficits, lowering gross inflation rates, and addressing banking non-performing assets. Implementing these measures would enhance macroeconomic stability and strengthen the rupee’s attractiveness.

Conclusion

• The government’s road map for the internationalisation of the rupee holds immense potential for Indian businesses, financial stability, and the government’s ability to finance deficits. With predictable currency management policies and a phased approach, the rupee’s journey towards internationalisation can contribute to India’s economic growth and strengthen its position in the global economy.

Also read:

Using a rupee route to get around a dominating dollar

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Context

The report of the Standing Committee on External Affairs on ‘India and bilateral investment treaties (BITs)’ was presented to Parliament last month.

Factor’s that necessitated the review of India’s BITs

• Investor’s started suing India frequently: Since 2011, when India lost its first investment treaty claim in White Industries v. India, foreign investors have sued India around 20 times for alleged BIT breaches.
• This made India the 10th most frequent respondent-state globally in terms of investor-state dispute settlement (ISDS) claims from 1987 to 2019 (UNCTAD).
• Adoption of new Model BIT: India adopted a new Model BIT in 2016, which marked a significant departure from its previous treaty practice.
• Negotiating new BITs: India is in the process of negotiating new investment deals (separately or as part of free trade agreements) with important countries such as Australia and the U.K.

Recommendations of the Committee

• 1] Speed of the existing negotiations: India has signed very few investment treaties after the adoption of the Model BIT.
• It recommends that India expedite the existing negotiations and conclude the agreements at the earliest because a delay might adversely impact foreign investment.
•  2] Sign more BIT’s in core sector: The committee recommends that India should sign more BITs in core or priority sectors to attract FDI.
• Generally, BITs are not signed for specific sectors.
•  It will require an overhauling of India’s extant treaty practice that focuses on safeguarding certain kinds of regulatory measures from ISDS claims rather than limiting BITs to specific sectors.
• 3] Fine-tune Model BIT: Model BIT gives precedence to the state’s regulatory interests over the rights of foreign investors.
• The Model BIT should be recalibrated keeping two factors in mind:
• a) tightening the language of the existing provisions to circumscribe the discretion of ISDS arbitral tribunals.
• b) striking a balance between the goals of investment protection and the state’s right to adopt bonafide regulatory measures for public welfare.
• 4] Improve the capacity of government officials: The committee recommends bolstering the capacity of government officials in the area of investment treaty arbitration.
•  While the government has taken some steps in this direction through a few training workshops, more needs to be done.
• What is needed is an institutionalised mechanism for capacity-building through the involvement of public and private universities.
• The government should also consider establishing chairs in universities to foster research and teaching activities in international investment law.

Need to improve poor governance

• A very large proportion of ISDS claims against India is due to poor governance.
• This includes changing laws retroactively which led to Vodafone and Cairn suing India.
• Annulling agreement in the wake of imagined scam which resulted in taking away S-band satellite spectrum from Devas.
• The judiciary’s fragility in getting its act together (sitting on the White Industries case for enforcement of its commercial award for years).

Suggestions

• The Committee could have emphasised on greater regulatory coherence, policy stability, and robust governance structures to avoid ISDS claims.
• The government should promptly assemble an expert team to review the Model BIT.

Consider the question “India is one of the most frequent respondent-state globally in terms of investor-state dispute settlement (ISDS) claims. In context of this, examine the reasons for such frequent disputes and suggest the way forward.” 

Conclusion

The committee’s report on India’s BITs have novel suggestions, but it is lacking in several aspects.

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Back2Basics: ISDS mechanism

• Investor-state dispute settlement (ISDS) is a mechanism in a free trade agreement (FTA) or investment treaty that provides foreign investors, with the right to access an international tribunal to resolve investment disputes.
•  ISDS promotes investor confidence and can protect against sovereign or political risk.
• If a country does not uphold its investment obligations, an investor can have their claim determined by an independent arbitral tribunal, usually comprising three arbitrators.

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Context

Given the enormous power that transnational corporations (TNCs) wield, questions about their accountability have arisen often. There have been many instances where the misconduct of TNCs has come to light such as the corruption scandal involving Siemens in Germany.

Holding TNCs accountable: Background

• The effort was made at the UN to develop a multilateral code of conduct on TNCs.
• However, due to differences between developed and developing countries, it was abandoned in 1992.
• Role of BITs: Aim was to use international law to institutionalise the forces of economic globalisation, leading to the spread of BITs.
• Asymmetry in BITs: These treaties promised protection to foreign investors under international law by bestowing rights on them and imposing obligations on states.
• This structural asymmetry in BITs, which confer rights on foreign investors but impose no obligations, relegated the demand for investor accountability.
• In 2014, the UN Human Rights Council established an open-ended working group with the mandate to elaborate on an international legally binding instrument on TNCs and other businesses concerning human rights.
• Since then, efforts are being made towards developing a treaty and finding ways to make foreign corporations accountable.
• The latest UN report is a step in that direction.

UN report on human rights-compatible international investment agreements

• The UN working group on ‘human rights, transnational corporations (TNCs) and other businesses’ has published a new report on human rights-compatible international investment agreements.
• It urges states to ensure that their bilateral investment treaties (BITs) are compatible with international human rights obligations.
• It emphasises investor obligations at the international level i.e., the accountability of TNCs in international law.

Using BITs to hold TNCs accountable

• BITs can be harnessed to hold TNCs accountable under international law.
• The issue of fixing accountability of foreign investors came up in an international law case, Urbaser v. Argentina (2016).
• Subjecting corporates to international law: In this case, the tribunal held that corporations can be subjects of international law and are under a duty not to engage in activities that harm or destroy human rights.
• The case played an important role in bringing human rights norms to the fore in BIT disputes.
• It also opened up the possibility of using BITs to hold TNCs accountable provided the treaty imposes positive obligations on foreign investors.
• Recalibrating BITs: In the last few years, states have started recalibrating their BITs by inserting provisions on investor accountability.
• Issues with BITs: However, these employ soft law language and are hortatory.
• They do not impose positive and binding obligations on foreign investors.
• They fall short of creating a framework to hold TNCs accountable under international law.

Takeaways for India

• The recent UN report has important takeaways for India’s ongoing reforms in BITs.
• Best endeavour clauses not enough: India’s new Model BIT of 2016 contains provisions on investor obligations.
• However, these exist as best endeavour clauses. They do not impose a binding obligation on the TNC.
• Impose positive binding obligations: India should impose positive and binding obligations on foreign investors, not just for protecting human rights but also for imperative issues such as promoting public health.
• The Nigeria-Morocco BIT, which imposes binding obligations on foreign investors such as conducting an environmental impact assessment of their investment, is a good example.

Consider the question ” Ensuring that the bilateral investment treaties (BITs) are compatible with international human rights obligations in the need of the hour. In light of this, assess the progress made globally on this issue and suggest way forward for India in framing its BITs.”

Conclusion

Reforms would help in harnessing BITs to ensure the answerability of foreign investors and creating a binding international legal framework to hold TNCs to account.

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Context

The recent move by Cairn to seize India’s sovereign assets in order to enforce its arbitration award has brought into focus the dispute and the related issues.

Utility of Bilateral Investment Treaties (BIT)

• After the World Wars, as more countries gained sovereignty, they tended to look at foreign investments as a form of neo-colonialism.
• Bilateral investment treaties became the primary tool to forge relationships between developed and developing countries.
• The BITs help to adopt standards for prompt, adequate and effective compensation in case of expropriation.
• With the advent of globalisation, BITs became the means for foreign investment in developing countries.
• Although the impact of investment agreements on foreign investments remains highly contextualised and inconclusive, these came to govern international investment relations.
• The BITs retained the old-world construct that allowed international arbitration.
• However, many developing countries view arbitration of tax matters as a breach of their sovereign right to tax.

The Cairn Energy case

• In 2012, explanations were added to the Income Tax Act 1961 — these provisions were deemed as having a retrospective effect.
• This was more in response to the Supreme Court’s decision in the Vodafone case which denied the income tax department’s assertion of tax claims arising from the offshore transfer of interest that substantially derived their value from India.
• The 2012 explanations to the IT Act indeed sought to fix tax avoidance. 
• Looking into the details of the Cairn case, one can see the series of reorganisations that tip-toed around tax laws of multiple jurisdictions, resulting in the non-payment of tax. 
• Taxing offshore indirect transfers — a structuring device to gain tax advantage from the indirect sale of assets — is not unique to India (336 tax treaties contain such an article).
• It is also possible to see that the underlying assets of the subsidiaries were immovable assets in India.
• The UK-India tax treaty allowed for taxation of capital gains as per Indian law.
• India challenged the admissibility of the case before the arbitration tribunal.
• However, the case rests on a distinction between tax and tax-related investment.
• Surely, all investments have tax implications and the acceptance of such a distinction could create problems even where tax is explicitly carved out from the bilateral investment treaties.
• The option of arbitration upon an unsuccessful Mutual Agreement Procedure (MAP) resolution is not available in India.
•  For this reason, over the years, there has been a rising trend in tax disputes involving BITs.
• The Cairn case is one such instance where arbitration was invoked especially since MAP was not an option.

Way forward

• The case raises many questions that administrators must address through reform.
• India’s model BIT introduced in 2016 rectifies the issue of the distinction between tax dispute and investment-related taxation dispute through the specific exclusion of taxation.
•  The recognition of a tax-related investment dispute, distinct from a tax dispute, should not undermine such a carve-out.

Conclusion

It is also important to note even if the award is enforced, the matter of tax avoidance stands pending before the High Court. Given the complexity, the only reasonable solution would be a negotiated settlement. Even if there’s a resolution in the Cairns case, questions of law would remain.

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Relaxation on Chinese FDI

• Last April, India had subjected all Chinese FDI to mandatory government screening.
• The aim was to curb opportunistic takeovers of Indian companies, a concern fuelled by sharp corrections in equity markets in March 2020.
• Several economies including the US, Australia, Canada and Germany faced similar concerns.
• They blocked specific takeover attempts, using special laws for national security screening of inward FDI.
•  In the absence of similar legislation, India did not differentiate between investments which raised genuine national security concerns and those that did not.
• This is a crucial shortcoming.
• With market indices now hovering at their peaks, reportedly India may allow Chinese FDI up to 25 per cent in equity under the automatic route.

Regulation of FDI and issues with it

• India regulates foreign investments primarily through FEMA.
• FEMA clearly provides two specific macro-prudential objectives — facilitating external trade and payments; and promoting orderly development and maintenance of foreign exchange markets in India.
• Accordingly, it empowers the central government and the RBI, acting in consultation with each other, to regulate capital account transactions.
• These regulations determine who can invest through the FDI route, in which sector and how much.
• In practice, however, FEMA regulations have often responded to concerns not strictly related to macro-prudential objectives.
• One such concern has been national security.

Need for the law to scrutinise FDI from national security angle

• Shortcoming of FEMA underscores the need for India to emulates its western peers and enact a statute specifically designed for national security screening of strategic FDI.
• Unlike FEMA, this new statute must explicitly lay down legal principles for determining when a foreign acquisition of an Indian company poses genuine national security threats.
• In this regard, a policy paper published by the Peterson Institute for International Economics three types of legitimate threats from foreign acquisitions.

3 Types of threat from foreign acquisitions

1) Dependency on foreign supplier

• The first threat arises if a foreign acquisition renders India dependent on a foreign-controlled supplier of goods or services crucial to the functioning of the Indian economy.
• For this threat to be credible, it needs to be further established that the industry in which the acquisition is supposed to take place is tightly concentrated, the number of close substitutes limited, and the switching costs are high.

2) Technology transfer

• The second threat emanates from a proposed acquisition transferring a technology or an expertise to a foreign-controlled entity that might be deployed by that entity or a foreign government in a manner harmful to India’s national interests.
• The credibility of this threat again depends on whether the market for such technology or expertise is tightly concentrated or if they are readily available elsewhere.

3) Threat of infiltration, surveillance or sabotage

• The third threat arises if a proposed acquisition allows insertion of some potential capability for infiltration, surveillance or sabotage via human or non-human agents into the provision of goods or services crucial to the functioning of Indian economy.
• This threat is particularly credible when the target company supplies crucial goods or services to the Indian government, its military or even critical infrastructure units and the switching costs are high.

Way forward

• The above stated 3 types of threats could provide conceptual clarity in the new statute could make national security assessments objective, transparent and amenable to the rule of law.
• On procedure, the statute must empower only the finance minister to reject certain strategic foreign acquisitions on national security grounds.
• Both the power and accountability mechanisms should be hardcoded into the statute itself, as is the case in some mature parliamentary democracies.
• For instance, the Australian Foreign Acquisitions and Takeovers Act, 1975 empowers the treasurer to block certain foreign acquisitions on national security grounds.
• Similarly, the Investment Canada Act, 1985 empowers a minister to reject certain foreign acquisitions.

Consider the question “India needs to recognise the national security threat emanating from strategic FDI. This requires identifying threats. In lights of this, examine the types of threats and suggest the ways to deal with it.” 

Conclusion

Overall, India’s tryst with Chinese FDI underscores the importance of identifying specific national security threats emanating from strategic FDI and addressing them objectively. This is too sensitive a matter to be left to capital controls under FEMA. A dedicated statute for national security screening of inward FDI would be best suited for handling such issues.

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