Can the Rupee Go Global While India Keeps Its Capital Controls

Since 2022, the Reserve Bank of India has actively promoted rupee-denominated trade settlement, allowing Indian exporters and importers to invoice and settle cross-border trade in rupees through special vostro accounts held by partner-country banks, with Russia becoming the most prominent example after Western sanctions cut Moscow off from dollar-based settlement following the invasion of Ukraine. Several other countries, including some in Africa and Southeast Asia, have set up similar rupee vostro arrangements, and Indian officials, including successive RBI governors, have spoken of rupee internationalisation as a strategic priority, both to reduce India's dependence on the dollar for trade financing and to give the rupee greater standing as a currency of genuine international use, rather than one that trades almost entirely against the dollar within India's own borders.

The ambition is understandable and, in narrow respects, achievable. But it runs into a structural tension that India's policymakers have never fully resolved and have shown no indication of wanting to resolve quickly: genuine reserve or internationally used currency status has historically required a fully open capital account, allowing unrestricted inflows and outflows of capital, something India has deliberately avoided maintaining since the 1991 balance of payments crisis taught a generation of Indian policymakers how dangerous unrestricted capital flows can be for a developing economy with a still-developing financial system.

What the Russia rupee experiment actually revealed

The rupee-rouble trade settlement mechanism, while a useful proof of concept and genuinely helpful for maintaining trade flows including oil purchases from Russia during the sanctions period, ran into a well-documented practical problem: Russia accumulated large rupee balances from oil exports to India that it struggled to use, because India's trade deficit with Russia meant rupees flowing to Russian entities from oil sales far exceeded what Russia could spend importing goods from India in return, and Russia had limited appetite to invest those rupee balances in Indian financial assets given capital account restrictions and the relatively narrow set of investment instruments available to a foreign central bank or state entity holding rupees. Reports suggested Russian entities holding tens of thousands of crores of unusable rupee balances at various points, a vivid illustration that a currency's usefulness for international settlement depends not just on the willingness of two trading partners to invoice in it but on there being a genuinely liquid and diverse enough set of financial instruments denominated in that currency for the counterpart to park its balances in productively.

The capital account dilemma

India's capital account remains subject to significant management: foreign portfolio investment in government bonds is capped and subject to specific investment routes, foreign direct investment faces sectoral caps and approval requirements in sensitive areas, and Indian residents face annual limits on how much they can remit abroad under the Liberalised Remittance Scheme. This is not accidental caution; it reflects the RBI's considered judgment, largely vindicated by India's relative resilience through the 2013 taper tantrum and subsequent global financial volatility episodes compared to some other emerging markets with more open capital accounts, that unrestricted capital flows into and out of a financial system with India's scale and its history of currency volatility risk create exactly the kind of destabilising boom-bust cycles that a more gradual, managed liberalisation approach has helped India avoid.

The tension is direct: a currency used widely for international trade settlement and reserve holding requires foreign holders to be able to invest their balances of that currency in a genuinely liquid, deep market of financial instruments and to be confident they can convert back into their own currency without facing capital controls or unpredictable restrictions. India's capital account management, however prudent for domestic financial stability, is in some tension with exactly this requirement for whatever currency aspires to broader international use.

What India has been willing to do

The RBI's approach has been incremental rather than transformative, consistent with its broader philosophy of capital account liberalisation as a gradual, sequenced process rather than a single decisive opening. India has progressively raised foreign portfolio investment limits in government securities, included Indian government bonds in major global bond indices including JPMorgan's emerging market bond index starting in 2024, a move expected to draw meaningful passive foreign investment inflows into rupee-denominated government debt over time, and expanded the set of countries and institutions permitted to hold rupee vostro accounts. Each of these steps genuinely deepens the pool of internationally accessible rupee-denominated assets without requiring a wholesale abandonment of capital account management.

The China comparison and its limits

China offers an instructive, if imperfect, parallel. Beijing has pursued renminbi internationalisation for over a decade, including establishing offshore renminbi trading centres in Hong Kong and elsewhere, promoting renminbi trade settlement, and gradually building out a network of currency swap lines with other central banks, all while maintaining significant capital controls of its own, arguably tighter than India's in some respects. The renminbi has achieved meaningful, if still modest relative to the dollar and euro, international use as a result, included in the IMF's Special Drawing Rights basket in 2016. This suggests full capital account convertibility is not strictly a precondition for meaningful currency internationalisation, but it also shows the ceiling on how far internationalisation can go without it; the renminbi remains a distant third or fourth in global reserve currency terms despite China's economic scale, precisely because international holders remain wary of a currency whose convertibility can be constrained by policy decisions in Beijing.

A sensible, if modest, ambition

The realistic reading of India's rupee internationalisation push is that it is a genuinely useful, incremental strategic hedge, reducing dependence on dollar settlement for a subset of trade relationships, particularly with sanctioned or dollar-constrained partners, and gradually deepening foreign participation in rupee assets through bond index inclusion and expanded portfolio investment routes. It is not, and India's own policymakers do not appear to believe it can currently be, a pathway to rupee reserve currency status in any near-term sense, given the capital account constraints that remain firmly in place for good domestic financial stability reasons. The honest way to evaluate progress on this front is not by asking whether the rupee is becoming a global reserve currency, which it is not on any near-term horizon, but by asking whether each incremental step, bond index inclusion, vostro account expansion, swap line agreements, is being calibrated carefully enough to deepen international rupee use without recreating the capital account vulnerabilities India's post-1991 policy framework was deliberately built to avoid. On that narrower, more honest question, the RBI's cautious sequencing looks considerably more defensible than the grander rhetoric sometimes surrounding it.