PROJECT REPORT

Indian Rupee as a
Global Currency
- An Exploratory Study
IGNOU MS 100
Contents
INTRODUCTION............................................................................................................... 4
EXCHANGE RATE ........................................................................................................... 6
QUOTATIONS ............................................................................................................... 6
FREE OR PEGGED ........................................................................................................ 8
NOMINAL AND REAL EXCHANGE RATES ............................................................ 9
BILATERAL VS EFFECTIVE EXCHANGE RATE .................................................. 10
UNCOVERED INTEREST RATE PARITY ............................................................... 10
BALANCE OF PAYMENTS MODEL ........................................................................ 10
ASSET MARKET MODEL.......................................................................................... 11
FLUCTUATIONS IN EXCHANGE RATES ............................................................... 12
FACTORS AFFECTING EXCHANGE RATES ............................................................. 13
ECONOMIC FACTORS .............................................................................................. 13
GOVERNMENT BUDGET DEFICITS OR SURPLUSES: .................................... 13
BALANCE OF TRADE LEVELS AND TRENDS: ................................................ 13
INFLATION LEVELS AND TRENDS: .................................................................. 14
POLITICAL CONDITIONS ......................................................................................... 14
MARKET PSYCHOLOGY .......................................................................................... 14
FLIGHTS TO QUALITY: ............................................................................................ 14
LONG-TERM TRENDS:.............................................................................................. 15
ECONOMIC NUMBERS: ............................................................................................ 15
TECHNICAL TRADING CONSIDERATIONS: ........................................................ 15
ALGORITHMIC TRADING IN FOREX..................................................................... 16
GLOBAL CURRENCY .................................................................................................... 17
THE EURO AND THE UNITED STATES DOLLAR ................................................ 17
HISTORY...................................................................................................................... 19
17TH AND 18TH CENTURY.................................................................................. 19
19TH - 20TH CENTURIES ...................................................................................... 20
HYPOTHETICAL SINGLE "TRUE" GLOBAL CURRENCY .................................. 21
ARGUMENTS FOR A GLOBAL CURRENCY ..................................................... 21
ARGUMENTS AGAINST A SINGLE GLOBAL CURRENCY ............................ 21
CONCLUDING ON SINGLE GLOBAL CURRENCY .............................................. 23
THE EURO ....................................................................................................................... 24

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 HISTORY OF EURO.................................................................................................... 24
CHRONOLOGY OF ADAPTATION OF EURO ........................................................ 26
EURO VALUE CHART ............................................................................................... 27
COMPARISON OF EURO AND USD ............................................................................ 28
US CURRENT ACCOUNT DEFICITS ....................................................................... 29
US - SUSTAINABILITY OF THE DEFICIT .............................................................. 31
EURO TAKING OVER USD ....................................................................................... 32
ANALYSIS OF INDIAN RUPEE .................................................................................... 33
A BRIEF HISTORY ..................................................................................................... 33
INDIAN RUPEE OVER THE LAST FEW YEARS .................................................... 35
ECONOMIC PREDICTIONS FOR INDIA ..................................................................... 36
BRIC ECONOMIES ..................................................................................................... 36
INDIA 2050................................................................................................................... 36
BASIS OF PREDICTIONS .......................................................................................... 39
INDIA UPSIDE POTENTIAL AND DOWNSIDE RISKS ............................................. 42
POWER OF INSTITUTIONS ...................................................................................... 42
THE POPULATION ADVANTAGE ........................................................................... 43
RISK OF INFORMATION TECHNOLOGY BUBBLE EXPLODING...................... 44
SHARE OF AGRICULTURE ...................................................................................... 45
STATISTICS FOR AND AGAINST THE COUNTRY .................................................. 46
INDIAN RUPEE AS A GLOBAL CURRENCY ............................................................. 47
TERMINOLOGIES .......................................................................................................... 50
BALANCE OF PAYMENTS ....................................................................................... 50
BALANCE OF TRADE................................................................................................ 50
FOREIGN EXCHANGE MARKET ............................................................................. 52
FOREIGN RESERVE CURRENCY ............................................................................ 52
GROSS DOMESTIC PRODUCT ................................................................................. 53
PURCHASING POWER PARITY ............................................................................... 55
REFERENCES AND BIBLIOGRAPHY ......................................................................... 57

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INTRODUCTION

Currency has been the medium of trade for thousands of years now. Various currencies

have been dominating the world trade during different eras. Here is a list of currencies

which dominated the world trade and had the respect of global acceptance over the last

15 centuries

• Byzantine gold nomisma (in 5th –7th Century)

• Arab Dinar (mancus or marabotin, 8th –12th Century)

• Florentine fiorino (13th – 14th Century)

• Venetian ducato (15th Century)

• Spanish “piece of eight” (16th – 17th Century )

• UK pound sterling (18th Century till World War II)

• US dollar (from second world war)

This study is aimed at analyzing the possibility of acceptance of Indian rupee as a global

currency. This intent was triggered by the fact that India is experiencing positive and

strong economic growth in the last few years. Its GDP has grown by more than three

fourths of what it was in 2002, in the subsequent four years, compared to a total growth

of about fifty percent in a decade preceding the year. The economic forecast for the next

two decades, by experts, indicates Asia as the hub of economic activity and India is

expected to reach the top of the list of developed nations. The economic forecast of the

Government of India is also in line with what the experts are predicting.

The analysis is done with Euro as the guiding factor, which has gained good ground ever

since its introduction about 10 years back. This currency was introduced very recently

and it has crossed various stages in a short span of time, which has encouraged in using

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its history as the base for analyzing the possibility of Indian currency to gain global

acceptance.

As mentioned in the Project Proposal though this topic was chosen with high

levels of interest and optimism, with the time limitation and the vastness

of the subject chosen, the effort is like bottling an ocean.

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EXCHANGE RATE

It is important to know what an exchange rate is and how it is affected to understand a

currency and its strength in the global economy. As we are discussing Indian Rupee as a

global currency, it is important to understand exchange rate as a concept before

proceeding further into the analysis.

The exchange rates (also known as the foreign-exchange rate, forex rate or FX rate)

between two currencies specify how much one currency is worth in terms of the other.

For example an exchange rate of 102 Japanese yen (JPY, ¥) to the United States dollar

(USD, $) means that JPY 102 is worth the same as USD 1. The foreign exchange market

is one of the largest markets in the world. By some estimates, about 3.2 trillion USD

worth of currency changes hands every day.

The spot exchange rate refers to the current exchange rate. The forward exchange rate

refers to an exchange rate that is quoted and traded today but for delivery and payment on

a specific future date.

QUOTATIONS

An exchange rate quotation is given by stating the number of units of "term currency" (or

"price currency" or "quote currency") that can be bought in terms of 1 unit currency (also

called base currency). For example, in a quotation that says the EURUSD exchange rate

is 1.4320 (1.4320 USD per EUR), the term currency is USD and the base currency is

EUR.

There is a market convention that determines which is the base currency and which is the

term currency. In most parts of the world, the order is:

EUR - GBP - AUD - NZD - USD - *** (where *** is any other currency).

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Thus if you are doing a conversion from EUR into AUD, EUR is the base currency, AUD

is the term currency and the exchange rate tells you how many Australian dollars you

would pay or receive for 1 euro. Cyprus and Malta which were quoted as the base to the

USD and *** were recently removed from this list when they joined the euro. In some

areas of Europe and in the non-professional market in the UK, EUR and GBP are

reversed so that GBP is quoted as the base currency to the euro. In order to determine

which is the base currency where both currencies are not listed (i.e. both are ***), market

convention is to use the base currency which gives an exchange rate greater than 1.000.

This avoids rounding issues and exchange rates being quoted to more than 4 decimal

places. There are some exceptions to this rule e.g. the Japanese often quote their currency

as the base to other currencies.

Quotes using a country's home currency as the price currency (e.g., EUR 1.00 = $1.58 in

the US) are known as direct quotation or price quotation (from that country's perspective)

and are used by most countries.

Quotes using a country's home currency as the unit currency (e.g., $0.97 AUD = $1.00

US) are known as indirect quotation or quantity quotation and are used in British

newspapers and are also common in Australia, New Zealand and the Eurozone.

Direct quotation: 1 foreign currency unit = x home currency units

Indirect quotation: 1 home currency unit = x foreign currency units

Note that, using direct quotation, if the home currency is strengthening (i.e., appreciating,

or becoming more valuable) then the exchange rate number decreases. Conversely if the

foreign currency is strengthening, the exchange rate number increases and the home

currency is depreciating.

When looking at a currency pair such as EURUSD, the first component (EUR in this

case) will be called the base currency. The second is called the term currency. For

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example: EURUSD = 1.5877, means EUR is the base and USD the term, so 1 EUR =

1.5877 USD.

Market convention from the early 1980s to 2006 was that most currency pairs were

quoted to 4 decimal places for spot transactions and up to 6 decimal places for forward

outrights or swaps. (The fourth decimal place is usually referred to as a "pip.") An

exception to this was exchange rates with a value of less than 1.000 which were usually

quoted to 5 or 6 decimal places. Although there is no fixed rule, exchange rates with a

value greater than around 20 were usually quoted to 3 decimal places and currencies with

a value greater than 80 were quoted to 2 decimal places. Currencies over 5000 were

usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR:

0.765432 - EURUSD: 1.5877 - GBPBEF: 58.234 - EURJPY: 165.29). In other words,

quotes are given with 5 digits. Where rates are below 1, quotes frequently include 5

decimal places.

In 2006 Barclays Capital broke with convention by offering spot exchange rates with 5 or

6 decimal places. The contraction of spreads (the difference between the bid and offer

rates) arguably necessitated finer pricing and gave the banks the ability to try and win

transaction on multibank trading platforms where all banks may otherwise have been

quoting the same price. A number of other banks have now followed this.

FREE OR PEGGED

If a currency is free-floating, its exchange rate is allowed to vary against that of other

currencies and is determined by the market forces of supply and demand. Exchange rates

for such currencies are likely to change almost constantly as quoted on financial markets,

mainly by banks, around the world. A movable or adjustable peg system is a system of

fixed exchange rates, but with a provision for the devaluation of a currency. For example,

between 1994 and 2005, the Chinese Yuan Renminbi (RMB) was pegged to the United

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States dollar at RMB 8.2768 to $1. China was not the only country to do this; from the

end of World War II until 1966, Western European countries all maintained fixed

exchange rates with the US dollar based on the Bretton Woods system.

NOMINAL AND REAL EXCHANGE RATES

The nominal exchange rate e is the price in domestic currency of one unit of a foreign

currency.

The real exchange rate (RER) is defined as, where P * is the foreign price level and P the

domestic price level. P and P * must have the same arbitrary value in some chosen base

year. Hence in the base year, RER = e.

The RER is only a theoretical ideal. In practice, there are many foreign currencies and

price level values to take into consideration. Correspondingly, the model calculations

become increasingly more complex. Furthermore, the model is based on purchasing

power parity (PPP), which implies a constant RER. The empirical determination of a

constant RER value could never be realised, due to limitations on data collection. PPP

would imply that the RER is the rate at which an organization can trade goods and

services of one economy (e.g. country) for those of another. For example, if the price of a

good increase 10% in the UK, and the Japanese currency simultaneously appreciates 10%

against the UK currency, then the price of the good remains constant for someone in

Japan. The people in the UK, however, would still have to deal with the 10% increase in

domestic prices. It is also worth mentioning that government-enacted tariffs can affect the

actual rate of exchange, helping to reduce price pressures. PPP appears to hold only in the

long term (3–5 years) when prices eventually correct towards parity.

More recent approaches in modeling the RER employ a set of macroeconomic variables,

such as relative productivity and the real interest rate differential.

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BILATERAL VS EFFECTIVE EXCHANGE RATE

Bilateral exchange rate involves a currency pair, while effective exchange rate is

weighted average of a basket of foreign currencies, and it can be viewed as an overall

measure of the country's external competitiveness. A nominal effective exchange rate

(NEER) is weighted with trade weights. A real effective exchange rate (REER) adjusts

NEER by appropriate foreign price level and deflates by the home country price level.

Compared to NEER, a GDP weighted effective exchange rate might be more appropriate

considering the global investment phenomenon.

UNCOVERED INTEREST RATE PARITY

Uncovered interest rate parity (UIRP) states that an appreciation or depreciation of one

currency against another currency might be neutralized by a change in the interest rate

differential. If US interest rates exceed Japanese interest rates then the US dollar should

depreciate against the Japanese yen by an amount that prevents arbitrage. The future

exchange rate is reflected into the forward exchange rate stated today. In our example, the

forward exchange rate of the dollar is said to be at a discount because it buys fewer

Japanese yen in the forward rate than it does in the spot rate. The yen is said to be at a

premium.

UIRP showed no proof of working after 1990s. Contrary to the theory, currencies with

high interest rates characteristically appreciated rather than depreciated on the reward of

the containment of inflation and a higher-yielding currency.

BALANCE OF PAYMENTS MODEL

This model holds that a foreign exchange rate must be at its equilibrium level - the rate

which produces a stable current account balance. A nation with a trade deficit will

experience reduction in its foreign exchange reserves which ultimately lowers

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(depreciates) the value of its currency. The cheaper currency renders the nation's goods

(exports) more affordable in the global market place while making imports more

expensive. After an intermediate period, imports are forced down and exports rise, thus

stabilizing the trade balance and the currency towards equilibrium.

Like PPP, the balance of payments model focuses largely on tradable goods and services,

ignoring the increasing role of global capital flows. In other words, money is not only

chasing goods and services, but to a larger extent, financial assets such as stocks and

bonds. Their flows go into the capital account item of the balance of payments, thus,

balancing the deficit in the current account. The increase in capital flows has given rise to

the asset market model.

ASSET MARKET MODEL

The explosion in trading of financial assets (stocks and bonds) has reshaped the way

analysts and traders look at currencies. Economic variables such as economic growth,

inflation and productivity are no longer the only drivers of currency movements. The

proportion of foreign exchange transactions stemming from cross border-trading of

financial assets has dwarfed the extent of currency transactions generated from trading in

goods and services.

The asset market approach views currencies as asset prices traded in an efficient financial

market. Consequently, currencies are increasingly demonstrating a strong correlation

with other markets, particularly equities.

Like the stock exchange, money can be made or lost on the foreign exchange market by

investors and speculators buying and selling at the right times. Currencies can be traded

at spot and foreign exchange options markets. The spot market represents current

exchange rates, whereas options are derivatives of exchange rates

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FLUCTUATIONS IN EXCHANGE RATES

A market based exchange rate will change whenever the values of either of the two

component currencies change. A currency will tend to become more valuable whenever

demand for it is greater than the available supply. It will become less valuable whenever

demand is less than available supply (this does not mean people no longer want money, it

just means they prefer holding their wealth in some other form, possibly another

currency).

Increased demand for a currency is due to either an increased transaction demand for

money, or an increased speculative demand for money. The transaction demand for

money is highly correlated to the country's level of business activity, gross domestic

product (GDP), and employment levels. The more people there are unemployed, the less

the public as a whole will spend on goods and services. Central banks typically have little

difficulty adjusting the available money supply to accommodate changes in the demand

for money due to business transactions.

The speculative demand for money is much harder for a central bank to accommodate but

they try to do this by adjusting interest rates. An investor may choose to buy a currency if

the return (that is the interest rate) is high enough. The higher a Country's interest rates,

the greater the demand for that currency. It has been argued that currency speculation can

undermine real economic growth, in particular since large currency speculators may

deliberately create downward pressure on a currency in order to force that central bank to

sell their currency to keep it stable (once this happens, the speculator can buy the

currency back from the bank at a lower price, close out their position, and thereby take a

profit).

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FACTORS AFFECTING EXCHANGE RATES

Although exchange rates are affected by many factors, in the end, currency prices are a

result of supply and demand forces. The world's currency markets can be viewed as a

huge melting pot: in a large and ever-changing mix of current events, supply and demand

factors are constantly shifting, and the price of one currency in relation to another shifts

accordingly. No other market encompasses (and distills) as much of what is going on in

the world at any given time as foreign exchange.

Supply and demand for any given currency, and thus its value, are not influenced by any

single element, but rather by several. These elements generally fall into three categories:

economic factors, political conditions and market psychology.

ECONOMIC FACTORS

These include economic policy, disseminated by government agencies and central banks,

economic conditions, generally revealed through economic reports, and other economic

indicators.

Economic policy comprises government fiscal policy (budget/spending practices) and

monetary policy (the means by which a government's central bank influences the supply

and "cost" of money, which is reflected by the level of interest rates).

ECONOMIC CONDITIONS INCLUDE:

GOVERNMENT BUDGET DEFICITS OR SURPLUSES: The market usually reacts

negatively to widening government budget deficits, and positively to narrowing budget

deficits. The impact is reflected in the value of a country's currency.

BALANCE OF TRADE LEVELS AND TRENDS: The trade flow between countries

illustrates the demand for goods and services, which in turn indicates demand for a

country's currency to conduct trade. Surpluses and deficits in trade of goods and services

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reflect the competitiveness of a nation's economy. For example, trade deficits may have a

negative impact on a nation's currency.

INFLATION LEVELS AND TRENDS: Typically, a currency will lose value if there is

a high level of inflation in the country or if inflation levels are perceived to be rising. This

is because inflation erodes purchasing power, thus demand, for that particular currency.

However, a currency may sometimes strengthen when inflation rises because of

expectations that the central bank will raise short-term interest rates to combat rising

inflation.

Economic growth and health: Reports such as gross domestic product (GDP),

employment levels, retail sales, capacity utilization and others, detail the levels of a

country's economic growth and health. Generally, the more healthy and robust a country's

economy, the better its currency will perform, and the more demand for it there will be.

POLITICAL CONDITIONS

Internal, regional, and international political conditions and events can have a profound

effect on currency markets.

For instance, political upheaval and instability can have a negative impact on a nation's

economy. The rise of a political faction that is perceived to be fiscally responsible can

have the opposite effect. Also, events in one country in a region may spur positive or

negative interest in a neighboring country and, in the process, affect its currency.

MARKET PSYCHOLOGY

Market psychology and trader perceptions influence the foreign exchange market in a

variety of ways:

FLIGHTS TO QUALITY: Unsettling international events can lead to a "flight to

quality," with investors seeking a "safe haven". There will be a greater demand, thus a

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higher price, for currencies perceived as stronger over their relatively weaker

counterparts. The Swiss franc has been a traditional safe haven during times of political

or economic uncertainty.

LONG-TERM TRENDS: Currency markets often move in visible long-term trends.

Although currencies do not have an annual growing season like physical commodities,

business cycles do make themselves felt. Cycle analysis looks at longer-term price trends

that may rise from economic or political trends.

"Buy the rumor, sell the fact:" This market truism can apply to many currency situations.

It is the tendency for the price of a currency to reflect the impact of a particular action

before it occurs and, when the anticipated event comes to pass, react in exactly the

opposite direction. This may also be referred to as a market being "oversold" or

"overbought". To buy the rumor or sell the fact can also be an example of the cognitive

bias known as anchoring, when investors focus too much on the relevance of outside

events to currency prices.

ECONOMIC NUMBERS: While economic numbers can certainly reflect economic

policy, some reports and numbers take on a talisman-like effect: the number itself

becomes important to market psychology and may have an immediate impact on short-

term market moves. "What to watch" can change over time. In recent years, for example,

money supply, employment, trade balance figures and inflation numbers have all taken

turns in the spotlight.

TECHNICAL TRADING CONSIDERATIONS: As in other markets, the accumulated

price movements in a currency pair such as EUR/USD can form apparent patterns that

traders may attempt to use. Many traders study price charts in order to identify such

patterns.

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ALGORITHMIC TRADING IN FOREX

Electronic trading is growing in the FX market, and algorithmic trading is becoming

much more common. According to financial consultancy Celent estimates, by 2008 up to

25% of all trades by volume will be executed using algorithm, up from about 18% in

2005.

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GLOBAL CURRENCY

The US dollar and euro are by far the most used currencies in terms of global reserves.

In the foreign exchange market and international finance, a world currency or global

currency refers to a currency in which the vast majority of international transactions take

place and which serves as the world's primary reserve currency.

Currencies have many forms depending on several properties: type of issuance, type of

issuer and type of backing. The particular configuration of those properties leads to

different types of money. The pros and cons of a currency are strongly influenced by the

type proposed. Consider, for example, the properties of a complementary currency.

THE EURO AND THE UNITED STATES DOLLAR

Since the mid-20th century, the de facto world currency has been the United States dollar.

According to Robert Gilpin in Global Political Economy: Understanding the International

Economic Order (2001): "Somewhere between 40 and 60 percent of international

financial transactions are denominated in dollars. For decades the dollar has also been the

world's principal reserve currency; in 1996, the dollar accounted for approximately two-

thirds of the world's foreign exchange reserves".

Many of the world's currencies are pegged against the dollar. Some countries, such as

Ecuador, El Salvador, and Panama, have gone even further and eliminated their own

currency in favour of the United States dollar. The dollar continues to dominate global

currency reserves, with 63.9% held in dollars, as compared to 26.5% held in Euros.

Since 1999, the dollar's dominance has begun to be eroded by the euro, which represents

a larger size economy, and has the prospect of more countries adopting the euro as their

national currency. The euro inherited the status of a major reserve currency from the

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German Mark (DM), and since then its contribution to official reserves has risen as banks

seek to diversify their reserves and trade in the Eurozone continues to expand.

██ Eurozone, the originator in control of the euro

██ External adopters of the euro

██ Currencies pegged to the euro

██ Currencies pegged to the euro within a narrow band

██ United States, the originator in control of the US dollar

██ External adopters of the US dollar

██ Currencies pegged to the US dollar

██ Currencies pegged to the US dollar within a narrow band

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As with the dollar, quite a few of the world's currencies are pegged against the euro. They

are usually Eastern European currencies like the Estonian Kroon and the Bulgarian Lev,

plus several West African currencies like the Cape Verdean escudo and the CFA franc.

Other European countries, while not being EU members, have adopted the euro due to

currency unions with member states, or by unilaterally superseding their own currencies:

Andorra, Kosovo, Monaco, Montenegro, San Marino, and Vatican City.

As of December 2006, the euro surpassed the dollar in the combined value of cash in

circulation. The value of euro notes in circulation has risen to more than €610 billion,

equivalent to US$800 billion at the exchange rates at the time (today equivalent to circa

US$968 billion).

HISTORY

17TH AND 18TH CENTURY

In the 17th and 18th century, the use of silver Spanish dollars or "pieces of eight" spread

from the Spanish territories in the Americas eastwards to Asia and westwards to Europe

forming the first ever worldwide currency. Spain's political supremacy on the world

stage, the importance of Spanish commercial routes across the Atlantic and the Pacific,

and the coin's quality and purity of silver helped it become internationally accepted for

over two centuries. It was legal tender in Spain's Pacific territories of the Philippines,

Micronesia, Guam and the Caroline Islands and later in China and other Southeast Asian

countries until the mid 19th century. In the Americas it was legal tender in all of South

and Central America (except Brazil) as well as in the U.S. and Canada until the mid-19th

century. In Europe the Spanish dollar was legal tender in the Iberian Peninsula, in most of

Italy including: Milan, the Kingdom of Naples, Sicily and Sardinia, as well as in the

Franche-Comté (France), and in the Spanish Netherlands. It was also used in other

European states including the Austrian Habsburg territories.

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19TH - 20TH CENTURIES

Prior to and during most of the 1800s, international trade was denominated in terms of

currencies that represented weights of gold. Most national currencies at the time were in

essence merely different ways of measuring gold weights (much as the yard and the

meter both measure length and are related by a constant conversion factor). Hence some

assert that gold was the world's first global currency. The emerging collapse of the

international gold standard around the time of World War I had significant implications

for global trade.

In the period following the Bretton Woods Conference of 1944, exchange rates around

the world were pegged against the United States dollar, which could be exchanged for a

fixed amount of gold. This reinforced the dominance of the US dollar as a global

currency.

Since the collapse of the fixed exchange rate regime and the gold standard and the

institution of floating exchange rates following the Smithsonian Agreement in 1971, most

currencies around the world have no longer been pegged against the United States dollar.

However, as the United States remained the world's preeminent economic superpower,

most international transactions continued to be conducted with the United States dollar

and it has remained the de facto world currency.

Only two serious challengers to the status of the United States dollar as a world currency

have arisen. During the 1980s, the Japanese yen became increasingly used as an

international currency, but that usage diminished with the Japanese recession in the

1990s. More recently, the euro has increasingly competed with the United States dollar in

usage in international finance.

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HYPOTHETICAL SINGLE "TRUE" GLOBAL CURRENCY

An alternative definition of a world or global currency refers to a hypothetical single

global currency, as the proposed Terra or the Dey (acronym for Dollar Euro Yen),

produced and supported by a central bank which is used for all transactions around the

world, regardless of the nationality of the entities (individuals, corporations,

governments, or other organisations) involved in the transaction. No such official

currency currently exists.

There are many different variations of the idea, including a possibility that it would be

administered by a global central bank or that it would be on the gold standard.

Supporters often point to the euro as an example of a supranational currency successfully

implemented by a union of nations with disparate languages, cultures, and economies.

Alternatively, digital gold currency can be viewed as an example of how global currency

can be implemented without achieving national government consensus.

A limited alternative would be a world reserve currency issued by the International

Monetary Fund, as an evolution of the existing Special Drawing Rights and used as

reserve assets by all national and regional central banks.

ARGUMENTS FOR A GLOBAL CURRENCY

Advocates of a global currency often argue that such a currency would not suffer from

inflation, which, in extreme cases, has had disastrous effects for economies. In addition,

many argue that a global currency would make conducting international business more

efficient and would encourage FDI.

ARGUMENTS AGAINST A SINGLE GLOBAL CURRENCY

Some economists argue that a single global currency is unworkable given the vastly

different national political and economic systems in existence.

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LOSS OF NATIONAL MONETARY POLICY

With one currency, there can only be one interest rate. This is not true - government bond

spreads in the Eurozone show e.g. Greece 100bps above Germany. This results in

rendering each present currency area unable to choose the interest rate which suits its

economy best. If, for example, the United States were to have an economic boom while

the European Union slumped into a depression, this period would be eased if each could

choose (whether by market forces or by fiat) the interest rate which best fitted its needs

— in this case, a relatively high interest rate in the former, and a relatively low one in the

latter.

POLITICAL DIFFICULTIES

In the present world, nations are not able to work together closely enough to be able to

produce and support a common currency. There has to be a high level of trust between

different countries before a true world currency could be created. A world currency might

even undermine national sovereignty of smaller states.

Most modern currencies have an interest rate, while one of the largest religions in the

world, Islam, is against the idea of paying interest for loans. This might prove to be an

unsolvable problem for a world currency, if religious views concerning interest do not

moderate. This is not necessarily a fatal flaw, however, as a large number of religious

adherents who oppose the paying of interest are still currently able to take advantage of

banking facilities in their countries which are able to cater to this. An example of this

might be Islamic banking, which operates well enough in nations where the central bank

sets interest rates for most other transactions.

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ECONOMIC DIFFICULTIES

Some economists argue that a single world currency is unnecessary, because the U.S.

dollar already provides many of the benefits of a world currency while avoiding some of

the costs.

If the world does not form an optimum currency area, then it would be economically

inefficient for the world to share one currency.

A further argument is most easily conveyed by an analogy. Water carried in a biscuit

baking pan will rapidly flow from high points to the lowest point, causing a sudden

uncontrollable imbalance that forces the high points higher and the low point lower. The

same quantity of water in cups on the biscuit pan will have no such inherent instability.

Hegemonic currencies, free of regional limitations, flow rapidly away from high risk

areas exacerbating their problems disproportionately to original causes. Such events are

very damaging to the prosperity of the affected area. See for example the events leading

up to, and subsequence consequences of, the Corralito in Argentina. For those with the

power to do so, predicting, or even causing, such capital flights can lead to immensely

profitable speculations; so profitable indeed that their likelihood of occurrence increases

in proportion with the scale of the currency involved.

CONCLUDING ON SINGLE GLOBAL CURRENCY

Though there are lots of arguments about having a single global currency, there are no

signs of such a currency coming up in the near future. This being the case, we have to

have USD as the widely accepted currency of exchange or some other currency must take

over that position. Euro’s possibility of taking up that position is presented hereunder

through an analytical study of the introduction and growth of euro.

Page 23 of 57
THE EURO

HISTORY OF EURO

History was made on 1st January 1999 when eleven European Union countries (later to

become twelve) irrevocably established the conversion rates between their respective

national currencies and the euro and created a monetary union with a single currency,

giving birth to the euro.

In these twelve countries (Belgium, Germany, Greece, Spain, France, Ireland, Italy,

Luxembourg, the Netherlands, Austria, Portugal and Finland), euro banknotes and coins

entered circulation on 1st January 2002.

But the history of Europe’s common currency has been a long time in the making and can

be charted back to the origins of the European Union itself.

Origins of the euro: Final stage of EMU - birth of the euro

• 1 January 1999: Birth of the euro

The euro became the new currency for eleven Member States and a single monetary

policy was introduced under the authority of the ECB, heralding the third and final stage

of monetary union.

Legally, the participating national currencies had ceased to exist and became ‘non-

decimal sub-divisions’ of the euro.

Euro area financial markets switched to the euro, including foreign exchange, share and

bond markets. New euro area government debt was exclusively issued in euro as from

that day.

The three year transition period before the introduction of euro notes and coins began,

with the principle of ‘no compulsion, no prohibition’ meaning people and businesses had

the freedom to carry out transactions in euro, but were under no obligation to do so.
Page 24 of 57
• 20 June 2000: Decision on Greek membership of euro area

EU Heads of State and Government meeting at the Feira European Council decided that

Greece had fulfilled the convergence criteria and would join the euro from January 2001.

The rate for conversion of Greek drachma to the euro was also announced.

• 28 September 2000: Danish referendum rejects euro-area membership

Danes voted not to adopt the euro in a national referendum on membership of the single

currency.

However, the Danish kroner continued to shadow the euro as a member of the ERM II.

• September 2001: Pre-circulation distribution of euro notes and coins

Though not yet legally in circulation, the first stocks of euro coins and notes were

distributed to commercial banks and post offices in so-called ‘frontloading’ operations in

advance of the introduction of notes and coins on 1 January.

Banks in turn began ‘sub-frontloading’ these stocks to retail customers like shops, and

some small quantities of banknotes were made available to businesses for training

purposes.

The arrangements and timing differed between Member States according to their

individual National Changeover Plans.

The euro was introduced to world financial markets as an accounting currency in 1999

and launched as physical coins and banknotes in 2002. It replaced the former European

Currency Unit (ECU) at a ratio of 1:1.

The euro is managed and administered by the Frankfurt-based European Central Bank

(ECB) and the European System of Central Banks (ESCB) (composed of the central

banks of its member states). As an independent central bank, the ECB has sole authority

Page 25 of 57
to set monetary policy. The ESCB participates in the printing, minting and distribution of

notes and coins in all member states, and the operation of the Eurozone payment systems.

CHRONOLOGY OF ADAPTATION OF EURO

Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands,

1999
Austria, Portugal and Finland

2001 Greece

2002 Introduction of euro banknotes and coins

2007 Slovenia

2008 Cyprus, Malta

Page 26 of 57
EURO VALUE CHART

The chart hereunder shows the gradual strengthening of Euro over the last 5 years over

USD. Due to various factors, ever since its introduction, the value of Euro consistently

went up as against the USD. The sudden dip towards the second half of 2008 was mainly

due to oil prices at their record high. As most of the OPEC nations used USD as their

billing currency, the value of Euro went down as the oil dues were to be settled by

purchasing USD. This increased the demand for USD resulting in better conversion rate

as against Euro. However, towards the end of 2008, the Euro started regaining its

strength.

Source: Reserve Bank of India - Historical Exchange Rates

The chart here under gives the international Oil price to know how it trended towards the

latter half of 2008.

Page 27 of 57
Source: www.opec.org

COMPARISON OF EURO AND USD

Given hereunder is a comparison of Eurozone with US. The comparison shows that

Eurozone is almost similar to the US. However, USD has prevailed as global currency for

more than half a century compared to EURO which is in its early stages as a foreign

exchange reserve currency.

EURO Area US

GDP: 15% GDP: 20.5%

Used as Reserve currency:

12.5% Used as Reserve currency: 66%

Economy: Much smaller Economy: much larger

World exports: 19.5% World exports: 15%

Economies as large as US and net creditors to the world.

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Taking the above listed comparative factors as cue, the global reserve currency has been

slowly shifting from USD to Euro over the last decade, ever since the inception. As the

Japanese economy has been slowing down comparatively and also because of the fact

that dollar was losing some of its might to Euro, which is a very new currency to gain

complete international trust, we could see some increase in the Pound Sterling as well

since 1999.

The chart given hereunder shows the mix of the top four Reserve Currencies of the world

over the last decade.

US CURRENT ACCOUNT DEFICITS

The chart hereunder gives some idea on the status of the US current account deficit over

the past few years and the trend is still continuing into 2009. For a normal country, this is

really an alarming number.

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The large effect of the U.S. current account deficit on exchange rates makes it a risk-

factor for the global economy. Normally, when an economy runs a persistent trade

deficit, its default risk grows as debt mounts, reducing the currency’s value. But the U.S.

is an exception because of the dollar’s anchor currency status, which allows it to pay for

imports with its own currency. In addition, trade partners are eager to accumulate dollar

assets as foreign reserves as well as to bolster confidence in their currency.

Thus while an expanding current account deficit works to weaken the dollar, in reality the

dollar can maintain its strength as long as the flow of funds into the U.S. remains stable.

If the U.S. economy were suffering from inflation and stagnation as in the 1970s,

confidence in the dollar would be a pressing issue. But after the vigorous growth of the

late 1990s, the U.S. now enjoys a strong position in the global economy, and confidence

in the U.S. economy is not likely to falter soon. What we can say is that the current

account deficit poses a threat to the global economy in the medium to long term, and

warrants corrective action as early as possible.

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US - SUSTAINABILITY OF THE DEFICIT

Federal Reserve Chairman Alan Greenspan commented that the expanding current

account deficit is not an immediate problem, but cannot be sustained indefinitely.

The problem of sustainability is twofold. First, if the current account deficit remains at

over 6% of nominal GDP year after year, the cumulative effect over the next decade will

be equivalent to almost 100% of nominal GDP. This will greatly aggravate the default

risk.

Second, on the flow side, Treasury securities already comprise the bulk of foreign-owned

assets in the U.S. As foreigners continue to buy more Treasury securities, interest

payments to abroad will grow, worsening the income account within the current account

balance. This means that outstanding foreign-owned assets in the U.S. and the current

account deficit will start expanding in a vicious cycle. The problem can be contained as

long as interest payments are limited, but the danger exists that interest payments and the

current account deficit will start to snowball at some point.

Moreover, not all gains from stock and bond investments by foreigners will flow abroad;

a portion will be reinvested as long as the economy continues to perform and enjoy

strong confidence. Nonetheless, as foreign-owned assets in the U.S. grow at an

accelerating rate, the net international investment position of the U.S. will deteriorate

more quickly.

US also considers the fact that by unsettling the country’s economy, the other countries

of the world will end up in affecting their economies as well. This is because of the

reason that 20% of the world GDP is contributed by US and economic slowdown in US

will result in global economic slowdown.

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EURO TAKING OVER USD

Considering the above facts, it can be concluded that Euro will take time to reach similar

status as the Dollar. Dollar will still prevail, especially in unstable economies. This is

mainly because of the factor that most of the international transactions are denominated

in USD. Having to pay their international dues in Dollar, it is important for the small and

unstable economies to hold dollars in their reserve.

The other advantage US has over Euro is that Euro is a currency of a group of nations

who have agreed to function as one as against US which is a single country with one

political and economic system. This makes USD more acceptable in the international

financial system compared to the Euro.

Whereas, considering the state of the US economy and it inaction to correct deficit

position, Euro has a chance of take over. There are some positive indicators which we

have seen in the form of increased holding of Euro as reserve currency and Euro crossing

USD in terms of currency in circulation across the globe.

DOLLAR STILL COUNTS

At least in the short run…

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ANALYSIS OF INDIAN RUPEE

A BRIEF HISTORY

India was one of the earliest issuers of coins (circa 6th century BC). The first "rupee" is

believed to have been introduced by Sher Shah Suri (1486-1545), based on a ratio of 40

copper pieces (paisa) per rupee. Among the earliest issues of paper rupees were those by

the Bank of Hindustan (1770-1832), the General Bank of Bengal and Bihar (1773-75,

established by Warren Hastings) and the Bengal Bank (1784-91), amongst others.

During British rule, and the first decade of independence, it was subdivided into 16

annas. Each anna was subdivided into 4 paise (also written pice) or 12 pies. Until 1815,

the Madras Presidency also issued a currency based on the fanam, with 12 fanams equal

to the rupee.

Historically, the rupee, derived from the Sanskrit word raupya, which means silver, was a

silver coin. This had severe consequences in the nineteenth century, when the strongest

economies in the world were on the gold standard. The discovery of vast quantities of

silver in the U.S. and various European colonies resulted in a decline in the relative value

of silver to gold. Suddenly the standard currency of India could not buy as much from the

outside world. This event was known as "the fall of the rupee."

In 1898, the rupee was tied to the gold standard through the British pound by pegging the

rupee at a value of 1 shilling 4 pence (i.e., 15 rupees = 1 pound). In 1920, the rupee was

increased in value to 2 shillings (10 rupees = 1 pound). However, in 1927, the peg was

once more reduced, this time to 1 shilling 6 pence (13⅓ rupees = 1 pound). This peg was

maintained until 1966, when the rupee was devalued and pegged to the U.S. dollar at a

rate of 7.5 rupees = 1 dollar (at the time, the rupee became equal to 11.4 British pence).

This peg lasted until the U.S. dollar devalued in 1971.

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The Indian rupee replaced the Danish Indian rupee in 1845, the French Indian rupee in

1954 and the Portuguese Indian escudo in 1961. Following independence in 1947, the

Indian rupee replaced all the currencies of the previously autonomous states. Some of

these states had issued rupees equal to those issued by the British (such as the Travancore

rupee). Other currencies included the Hyderabad rupee and the Kutch kori.

In 1957, decimalisation occurred and the rupee was divided into 100 naye paise (Hindi

for "new paise"). In 1964, the initial "naye" was dropped. Many still refer to 25, 50 and

75 paise as 4, 8 and 12 annas respectively.

The use of Indian rupee outside India is in Bhutan where the Bhutanese Ngultrum is at

par with the Indian Rupee and both are accepted in Bhutan. The Indian rupee is also

accepted in towns of Nepalese side of Nepal-India border. Indian rupee is also pegged by

the currency of these two countries.

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INDIAN RUPEE OVER THE LAST FEW YEARS

The Indian rupee has been more stable in the last five years and showed some signs of

strengthening before the oil price intervened and pulled down the value of the Rupee.

After hitting the historic INR 50 per USD, the rupee is now showing signs of gaining

grounds again. This can be seen in the strengthening trends over the last few months after

the oil price went down to sub $50 numbers. Though oil is not the only parameter, for a

growing economy like India, price of oil has a major impact on the value of the exchange.

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ECONOMIC PREDICTIONS FOR INDIA

India is one of the four nations which are expected to grow best over the next few

decades. These are called the BRIC economies: Brazil, Russia, India and China.

BRIC ECONOMIES

Goldman Sachs argues that the economic potential of Brazil, Russia, India, and China is

such that they may become among the four most dominant economies by the year 2050.

The thesis was proposed by Jim O'Neill, global economist at Goldman Sachs. These

countries encompass over twenty-five percent of the world's land coverage, forty percent

of the world's population and hold a combined GDP (PPP) of 15.435 trillion dollars. On

almost every scale, they would be the largest entity on the global stage. These four

countries are among the biggest and fastest growing Emerging Markets.

However, it is important to note that it is not the intent of Goldman Sachs to argue that

these four countries are a political alliance (such as the European Union) or any formal

trading association, like ASEAN. Nevertheless, they have taken steps to increase their

political cooperation, mainly as a way of influencing the United States position on major

trade accords, or, through the implicit threat of political cooperation, as a way of

extracting political concessions from the United States, such as the nuclear cooperation

with India.

INDIA 2050

By the year 2040, if things go according to prediction, India will be the third largest

economy in the world with a reasonably high per capita income. This is as per the

Goldman Sachs study titled `Dreaming with BRICs: The Path to 2050'. The report places

Brazil, Russia, India and China (identified as BRIC countries) among the fastest growing

economies over the next 50 years.

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The World Bank publishes estimates of gross national income (GNI) in terms of nominal

as well as purchasing power parity (PPP) of various economies.

According to the World Bank, India had a nominal GNI of $477 billion and a PPP GNI of

$2,913 billion in 2001. This yielded a per capita GNI of $460 in nominal terms and

$2,820 in PPP terms.

In PPP terms, India was already the fourth largest economy in 2001 after the U.S., China

and Japan. As Japan had a GNI of $3,246 billion in PPP terms that year, it is expected

that India will soon overtake it to become the third largest economy in PPP terms.

However, India's per capita income continues to be abysmally low, both in nominal and

PPP terms. The difference between the predictions of the investment bank's study and

current PPP estimates of the World Bank is that according to the Goldman Sachs study,

the Indian economy could be larger than that of Japan by 2032 in terms of nominal U.S.

dollar.

The study predicts that the size of the BRIC economies could exceed that of the G-6

countries, consisting of the U.S., Japan, Italy, France, Germany and the U.K., by 2039.

Of the G-6 countries, only the U.S. and Japan may remain among the six largest in U.S.

dollar terms by 2050. China could be the largest economy by 2041.

The table hereunder provides the USD GDP projections. The table following that gives

the GDP per-capita in USD terms.

Year 2000 2015 2025 2040 2050

Brazil 4338 4664 7781 16370 26592
China 854 3428 7051 18209 31367
India 468 1149 2331 8124 17366
Russia 2675 8736 16652 35314 49646
Japan 32960 38626 46391 55721 66805
USA 34797 45835 52450 69431 83710
Germany 22814 29111 32299 40966 48952

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 Year 2000 2015 2025 2040 2050
Brazil 762 952 1695 3740 6074
China 1078 4754 10213 26439 44453
India 469 1411 3174 12367 27803
Russia 391 1232 2264 4467 5870
Japan 4176 4858 5567 6039 6673
USA 9825 14786 18340 27229 35165
Germany 1875 2386 2604 3147 3603

The current trend of Indian GDP is in a consistent growing trend. The chart hereunder

gives the GDP of top 15 Ranked Countries in GDP terms.

Data Source: www.nationmaster.com Figures in Billion US$

India’s GDP Growth has been more since 2008 than it was in the ten year period from

1990.

Page 38 of 57
BASIS OF PREDICTIONS

The study assumes that the rise in GDP in US$ terms of the BRIC countries will come

from a mix of rise in real GDP and currency appreciation. The Goldman Sachs study

basically uses a growth model in terms of labour, capital stock and the level of `technical

progress' or `total factor productivity' to arrive at growth projections. Further, the model

of real exchange rates is calculated from the predictions of labour productivity growth.

This is because currencies tend to rise as higher productivity leads economies to converge

on PPP exchange rates.

The BRIC economies at present are way below their PPP rates. It is true that a pegged

exchange rate (for example, the Chinese Yuan peg against the dollar) may distort the

picture. In practice, the study presumes that real exchange rate appreciation may come

from a combination of nominal appreciation and higher inflation.

About two thirds of the increase in US$ GDP terms will come from higher real growth

with the balance through currency appreciation. The BRIC's real exchange rates could

appreciate by up to 300 per cent over the next 50 years, or at an average 2.5 per cent a

year. India's exchange rate is assumed to appreciate by 281 per cent during this period.

The present economic powers are mainly the U.S., the European Union countries and

Japan. Given the size of the population of the BRIC countries, their long-term economic

success would also have a major impact on the power equations in the world.

According to the study, India has the potential to grow the fastest among the four BRIC

countries over the next 30 to 50 years — higher than 5 per cent over the next 30 years

and close to 5 per cent as late as 2050.

Page 39 of 57
A major reason for this is that the decline in working age population will happen later for

India and Brazil than for Russia and China. For example, it is predicted that in 2010,

India will have a high 53.9 per cent of its population in the age group of 15-59 years.

The predictions are not unreasonable. As the report points out, South Korea's GDP

increased by nine times between 1970 and 2000; these projections are tame by

comparison. In fact, except for Brazil, the other three economies are already achieving

this kind of growth rates.

A basic assumption of the study is that the BRIC countries maintain policies and develop

institutions that are supportive of growth. These include sound macro-economic policies

and a stable macro-economic background (low inflation, supportive government policies,

sound public finance and a well managed exchange rate), stable political institutions,

openness and high levels of education.

The BRIC report is timely, especially in the Indian context. Recently, India witnessed its

foreign exchange reserves crossing US$ 100 billion. However, this is not an unalloyed

blessing as there has been considerable upward pressure on the rupee.

This year India will probably achieve a GDP growth rate of around 7 per cent, mainly on

the back of a rise in agricultural output on account of bountiful rains.

However, if the country is aiming for a growth rate of around 7 per cent per annum over

the next decade, then it will need an investment rate of about 28 per cent given an

Incremental Capital Output Ratio (ICOR) of 4.

To achieve an investment rate of 28 per cent, the country will have to increase its

domestic savings rate to around 25-26 per cent and meet the balance from a current

account deficit.

Page 40 of 57
By running up a current account surplus and building excessive reserves will not increase

GDP growth rates. For higher growth, policies that result in foreign exchange inward

remittances in various forms being invested in the Indian economy will have to be

introduced. Given the low per capita incomes and widespread poverty, the `India Shining'

campaign seems rather premature.

Given the comparative advantage of a skilled workforce available at low costs, backed by

huge foreign exchange reserves and food grain surplus, India has a historical opportunity

to fulfill the BRIC report predictions.

However, many things can go wrong even with reasonable projections, especially over a

long time horizon. In the case of India, both the government and the private sector need

to increase investments in education.

Fiscal deficit also needs to be brought down with a mix of expenditure control and better

tax compliance. India cannot be complacent on the economic reforms front.

Even with the kind of prediction provided by the report, India's per capita income will

continue to be the lowest among the four BRIC countries, and far lower than those of the

developed nations.

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INDIA UPSIDE POTENTIAL AND DOWNSIDE RISKS
Using a simple growth accounting framework, Dani Rodrik, Professor at Harvard

University and Arvind Subramanian of the IMF’s Research Department, project India’s

future potential output growth rate through 2025. They argue that there is perhaps more

upside potential than downside risks to their central estimate of annual growth, which is

close to 7 percent for aggregate output; or 5.5 percent for output per capita. Arguments

are also given for what can pull these projections up as well as those that can push these

rates down.

POWER OF INSTITUTIONS
The important upside potential for India is the quality of Institutions India has built ever

since independence. These institutions are meta-institutions such as democracy; the

legislature, judiciary; press; and the bureaucracy; and then there are meso-institutions

such as the Reserve Bank of India, Telecommunications Regulatory Authority of India,

vigilance commissions, etc.

If the recent literature on the role of institutions in determining long-run development is

correct, then simple econometric analysis suggests that India remains an underperformer,

with a level of income well below what it ought to be. India is far from reaping the

benefits of its institutional quality. India’s per capita income should be about 4-5 times

what it currently is.

In other words, India, having done the really hard work of building good economic and

political institutions—a stable democratic polity, reasonable rule of law and protection of

property rights—failed until the 1980s, to take advantage of it. Even small changes in

policies could help India grow rapidly. Thus, India’s growth in the near future (for the

next decade at least) will not need fundamental and difficult challenge of overcoming

institutional backwardness, but can rely on the easier task of taking advantage of existing

Page 42 of 57
institutions. Contrast this, for example, with China which has grown extremely rapidly in

the last quarter century, but which faces the inordinate challenge of large-scale

institutional transformation.

THE POPULATION ADVANTAGE

Though India’s population is one of the most criticized facts about India, the size of

India’s population has the ability to improve the expected growth projections of India.

High levels of human capital are a key prerequisite for a developing country to exploit

the benefits of technological progress. India’s stellar productivity growth in the last two

decades, and not just in the IT-sector, has benefited from its stock of highly educated

human capital. Going forward, this process is likely to be reinforced for at least two

reasons. First, the growing location of R&D facilities in India—in pharmaceuticals,

software and other IT-services—by foreign companies, will further enhance the scope for

dynamic benefits. Second, over the last three-four decades India did not fully reap the

benefits of its stock of human capital because a substantial share had moved overseas.

This dynamic is changing qualitatively. Cyclical factors such as 9/11 and the economic

downturn in the United States have reduced overseas demand for India’s human capital.

But there are also structural factors reinforcing this effect—as incomes rise and

opportunities grow within India, there is less of a push factor at work. Moreover,

technological change means that India can deliver services overseas without its labor

having to migrate. The more high skilled labor remains within India, the greater the scope

for spillover benefits to the Indian economy. Thus, outsourcing produces a double

whammy of benefits—India reaps the static efficiency benefits from the international

division of labor without foregoing the dynamic benefits that arise from labor emigration.

Amartya Sen has drawn attention to the disappointing post-Independence performance of

the Indian state in delivering education, reflected in very slow improvements in literacy

Page 43 of 57
rates, especially amongst women. While the supply of educational services by the state

was inadequate, Sen raised the puzzle as to why there was not greater demand for

education and hence greater pressure on the state to meet this demand. One answer to this

puzzle is that the private returns to literacy and basic education must have been low.

There is now evidence that the increasing opportunities that are spurring economic

growth also contribute to raising these returns, leading to a greater demand for

educational services—public and private—and hence in educational outcomes. In such an

event, the potential growth rate could reach as high as 8 percent. The positive side of this

the availability of Less Skilled Labour as well as High Skilled Labour to fuel the growth

of the country.

RISK OF INFORMATION TECHNOLOGY BUBBLE EXPLODING

Some of the recent growth (since the 1990s) in India has been driven by the explosion of

IT related services. One strand of skeptical thought holds that IT cannot be a long-run

source of growth because it currently accounts for such a small share of GDP and

employment. One response to this skepticism could refer to demand linkages: if one

sector grows, it creates demand for inputs of that sector and at the same time increases

incomes, generating demand for the entire economy. Nevertheless, this is not compelling

because it runs into the cold logic of accounting: a very small part of the economy will

have to grow at impossibly large rates to lift the whole economy. The more subtle and

more persuasive response to the skeptics’ concerns relates to the impact that the IT-

explosion could have on the economy’s long-run supply capacity. It is possible that the

IT-explosion, by visibly raising the rewards for being educated, will durably boost the

demand for educational services. Anecdotal evidence for this comes from the

mushrooming of English-language schools in backward states such as Bihar and the

agricultural hinterland of Punjab. Munshi and Rosenzweig (IMF Research Team) provide

systematic evidence from Mumbai on how the increased return to education is leading to

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expanded school enrollment by women and overhauling traditional caste structures. To be

sure, increased demand will relate in the first instance to the acquisition of specific skills

(such as fluency in English and computer proficiency). Over time, however, this demand

could percolate down the hierarchy of skill, improving basic educational outcomes.

According to Sen, this pressure from below was missing in the past, contributing to the

rather limited progress in educational outcomes.

Strict devotees of the accounting logic—that small sectors cannot lift the overall

economy— also fail to recognize that registered manufacturing played a key role in

overall economic performance in the 1980s and 1990s despite accounting for a small

share of total output of less than 10 percent. In the case of manufacturing, there may well

have been a supply externality at work—the acquisition of managerial and organizational

skills in manufacturing could have been beneficially transferred to services. With certain

service sectors [finance and telecommunications] similar spillover effects could be

generated, leveraging the contribution of these sectors beyond what might be expected

given their size.

SHARE OF AGRICULTURE
The conventional wisdom is that India is still beholden to the monsoon for its overall

economic performance because agriculture accounts for a large share of GDP. Of course,

a series of droughts could yet drag down the Indian growth trajectory. However, the

inexorable logic of development, and the experience of the last two decades, shows that

the hold of agriculture has declined sharply. Between 1980 and 2000, agriculture’s share

in GDP has declined by 16 percentage points to about 22 percent. Another 25 years of

growth along the lines of the 1990s will shrink agriculture’s share to about 12 percent,

further reducing its grip on the economy.

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STATISTICS FOR AND AGAINST THE COUNTRY

The following are some of the factors for the country to consider before taking up the

task of strengthening the currency. Once these factors are addressed the right way,

development of the country is more automatic. These are mainly taken from Nation

Master who sources their data mainly from US Central Intelligence Agency, United

Nations and Organisation for Economic Co-operation and Development.

• 40% of world poor population is in India. The country is ranked first in this.

• India is ranked high in the number of Micro, Small and Medium size enterprises

• India is ranked very low in the ‘Entrepreneurship – New Business Start-up Minimum

capital deployed’

• India is ranked poorly with reference to Export as percentage of GDP.

• India is ranked in the top five countries in the Net Capital Account - Balance of

Payments.

• India is ranked 5th in terms of GDP adjusted for Purchasing Power Parity.

• India is ranked poorly when it comes to Economic Freedom by an independent entity

heritage.org.

• India’s ranking is within the top 25 in terms of Gross Savings as percentage of GNI.

• India’s GDP growth rate is also highly ranked.

• India is right on top even in terms of External Aid Recipients.

• The ranking is on the top even with reference to External Debt values, and poorly

ranked when debt service is considered.

• India is also poorly ranked in terms of Corruption.

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INDIAN RUPEE AS A GLOBAL CURRENCY
India is expected to be the third largest economy in terms of GDP, by the year 2050. The

predicted numbers of the top 20 economies of the world is listed hereunder

Rank Country GDP (millions of USD)

1 China $70,710,000
2 United States $38,514,000
3 India $37,668,000
4 Brazil $11,366,000
5 Mexico $9,340,000
6 Russia $8,580,000
7 Indonesia $7,010,000
8 Japan $6,677,000
9 United Kingdom $5,133,000
10 Germany $5,024,000
11 Nigeria $4,640,000
12 France $4,592,000
13 South Korea $4,083,000
14 Turkey $3,943,000
15 Vietnam $3,607,000
16 Canada $3,149,000
17 Philippines $3,010,000
18 Italy $2,950,000
19 Iran $2,663,000
20 Egypt $2,602,000

Other than pure GDP terms, the indicators are positive as predicted by economists around

the world for India. Even within the country, each of the States is competing with the

other, to record better economic growth figures. They are working towards attracting

more and more private and foreign funds for the improvement of infrastructure and

industry within the states. And the states left behind will be under pressure to follow the

demonstration effect of the more successful states. This helps in the country growing as a

whole.

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However, if we have to consider the possibility of Indian rupee as a global currency, then

we have to answer a few questions with reference to the rupee fulfilling the

characteristics of a global currency.

Size of the economy is the first factor to consider. Even though we would have grown in

terms of GDP, in 2050, we can be expected to contribute about 10-12% of the global

whereas China will be contributing about 22-25%. Even in this increased GDP, India will

be having lot of its output internally consumed considering the size of the population

which is not so in the case of smaller economies, though they are behind us in the ranking

based on GDP. This means, India will be having relatively less international revenue,

which again means lesser foreign exchange reserves. The population forecast by the UN

also indicate that India will be ranked 1st in terms of population, ahead of China by 2030.

They expect this to happen even sooner but not later.

With increased population pressure, India will be busy working for self sustenance

compared to other economies like Russia. The increased population also increases the

density as land is a restricted resource. This will make lesser area available for industry

and agriculture. However, this challenge can be overcome by planned township and city

developments over the next few decades.

India has also built a strong institutional system which gives the country a big edge over

China and other emerging economies. This opens the gate for a domestic financial market

with lot of depth, openness and liquidity. This is another important factor for a currency

to be considered as a global currency.

Next is the free convertibility factor of the currency. Again this should not become a

challenge considering the sound financial system which is already in the making in India.

All that is required is minor policy changes to absorb shocks grow unhindered. However,

the currency should also be easily convertible globally. With improved ranking in the

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world economy, India will gain confidence of all the nations and this should facilitate the

improvement of financial relations with other countries of the world and hence better

convertibility of the Indian currency. This should also be necessitated by the fact that

Indian economy has grown and has strong trade links with most of the countries in the

world. Once this happen, the central banks of other countries will start stocking Indian

rupee as a part of their foreign currency reserves.

Macroeconomic policies of the country plays a major role in the in a currency getting

global acceptability. India should gain the confidence as a stable economy with the ability

to grow. Transparency of the political and financial system should also be felt, not just

present. India should also consciously take steps to increase the Rupee in circulation

around the world.

The economic forecasts of various countries becoming true may lead to the end of

monopoly status of a single country’s currency as a global currency, which was the way

of the world so far. This will give way to multiple global currency regimes. As many

economies emerge as equally as or more powerful than the current Euro zone or the US,

the single global currency will give way to multiple global currency. This is already seen

in the emergence of Euro and its acceptability and usage in the international trade

alongside USD.

Going by the results of the study, one must expect Indian Rupee to gain the recognition

as global currency over the years to come. Indian rupee is accepted as such in most of

India’s neighboring countries and some places in UK [mainly due to global presence of

Indians] and the confidence Indian economy is able to gain in the international financial

and economic system.

The 21st century will indeed see Indian Rupee emerge as one of the global

currencies.

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TERMINOLOGIES

BALANCE OF PAYMENTS

The IMF definition: "Balance of Payments is a statistical statement that summarizes

transactions between residents and nonresidents during a period." The balance of

payments comprises the current account, the capital account, and the financial account.

"Together, these accounts balance in the sense that the sum of the entries is conceptually

zero."

The current account consists of the goods and services account, the primary income

account and the secondary income account.

The financial account records transactions that involve financial assets and liabilities and

that take place between residents and nonresidents.

The capital account in the international accounts shows capital transfers receivable and

payable; and the acquisition and disposal of non-produced nonfinancial assets.

In economic literature, "capital account" is often used to refer to what is now called the

financial account and remaining capital account in the IMF manual and in the System of

National Accounts. The use of the term capital account in the IMF manual is designed to

be consistent with the System of National Accounts, which distinguishes between capital

transactions and financial transactions.

BALANCE OF TRADE

The balance of trade forms part of the current account, which also includes other

transactions such as income from the international investment position as well as

international aid. If the current account is in surplus, the country's net international asset

position increases correspondingly. Equally, a deficit decreases the net international asset

position.

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The trade balance is identical to the difference between a country's output and its

domestic demand (the difference between what goods a country produces and how many

goods it buys from abroad; this does not include money re-spent on foreign stocks, nor

does it factor the concept of importing goods to produce for the domestic market).

Measuring the balance of trade can be problematic because of problems with recording

and collecting data. As an illustration of this problem, when official data for the entire

world's countries are added up, exports exceed imports by a few percent; it appears the

world is running a positive balance of trade with itself. This cannot be true, because all

transactions involve an equal credit or debit in the account of each nation. The

discrepancy is widely believed to be explained by transactions intended to launder money

or evade taxes, smuggling and other visibility problems. However, especially for

developed countries, accuracy is likely.

Factors that can affect the balance of trade figures include:

Prices of goods manufactured at home (influenced by the responsiveness of supply)

Exchange rates

Trade agreements or barriers

Offset agreements

Other tax, tariff and trade measures

Business cycle at home or abroad

The balance of trade is likely to differ across the business cycle. In export led growth

(such as oil and early industrial goods), the balance of trade will improve during an

economic expansion. However, with domestic demand led growth (as in the United States

and Australia) the trade balance will worsen at the same stage in the business cycle.

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Strong GDP growth economies such as the United States, the United Kingdom, Australia

and Hong Kong run consistent trade deficits, as well as poorer countries also

experiencing a lot of investment.

Developed nations such as Canada, Japan, and Germany typically run trade surpluses.

China also has a trade surplus. A higher savings rate generally corresponds with a trade

surplus. Correspondingly, the United States with its negative savings rate consistently has

high trade deficits.

FOREIGN EXCHANGE MARKET

The foreign exchange (currency, forex or FX) market is where currency trading takes

place. FX transactions typically involve one party purchasing a quantity of one currency

in exchange for paying a quantity of another. The FX market is one of the largest and

most liquid financial markets in the world, and includes trading between large banks,

central banks, currency speculators, corporations, governments and other institutions. The

average daily volume in the global forex and related markets is continuously growing.

Traditional turnover was reported to be over US$ 3.2 trillion in April 2007 by the Bank

for International Settlements. Since then, the market has continued to grow. According to

Euro's annual FX Poll, volumes grew a further 41% between 2007 and 2008.

The foreign exchange market is the market for purchase and sale of foreign currencies.

The purpose for such a market is to facilitate trade and investment. The need for a foreign

exchange market arises because of the presence of multifarious international currencies

such as US Dollar, Pound Sterling, etc, and the need for trading in such currencies.

FOREIGN RESERVE CURRENCY

A currency which is widely held in international central bank reserves.

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A reserve currency (or anchor currency) is a currency which is held in significant

quantities by many governments and institutions as part of their foreign exchange

reserves. It also tends to be the international pricing currency for products traded on a

global market, such as oil, gold, etc.

This permits the issuing country to purchase the commodities at a marginally cheaper rate

than other nations, which must exchange their currency with each purchase and pay a

transaction cost. It also permits the government issuing the currency to borrow money at

a better rate, as there will always be a larger market for that currency than others.

The chart below gives the % mix of reserve currency held by central banks of the world.

It is apparent that Euro is gaining grounds cutting into the share of USD and YEN. There

is some upward trend seen in GBP as well. These are the four major currencies held as

reserve currency.

GROSS DOMESTIC PRODUCT

The gross domestic product (GDP) or gross domestic income (GDI) is one of the

measures of national income and output for a given country's economy. GDP is defined

as the total market value of all final goods and services produced within the country in a

given period of time (usually a calendar year). It is also considered the sum of a value

added at every stage of production (the intermediate stages) of all final goods and

services produced within a country in a given period of time, and it is given a money

value.

The most common approach to measuring and understanding GDP is the expenditure

method:

GDP = consumption + gross investment + government spending + (exports − imports),

or,

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GDP = C + I + G + (X-M).

"Gross" means depreciation of capital stock is not subtracted. If net investment (which is

gross investment minus depreciation) is substituted for gross investment in the equation

above, then the formula for net domestic product is obtained. Consumption and

investment in this equation are expenditure on final goods and services. The exports-

minus-imports part of the equation (often called net exports) adjusts this by subtracting

the part of this expenditure not produced domestically (the imports), and adding back in

domestic area (the exports).

Economists (since Keynes) have preferred to split the general consumption term into two

parts; private consumption, and public sector (or government) spending. Two advantages

of dividing total consumption this way in theoretical macroeconomics are:

Private consumption is a central concern of welfare economics. The private investment

and trade portions of the economy are ultimately directed (in mainstream economic

models) to increases in long-term private consumption.

If separated from endogenous private consumption, government consumption can be

treated as exogenous, so that different government spending levels can be considered

within a meaningful macroeconomic framework.

The chart below gives the GDP per capita profile of the world nations in 2007.

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PURCHASING POWER PARITY

The purchasing power parity (PPP) theory uses the long-term equilibrium exchange rate

of two currencies to equalize their purchasing power. Developed by Gustav Cassel in

1920, it is based on the law of one price: the theory states that, in ideally efficient

markets, identical goods should have only one price.

This purchasing power exchange rate equalizes the purchasing power of different

currencies in their home countries for a given basket of goods. Using a PPP basis is

arguably more useful when comparing differences in living standards on the whole

between nations because PPP takes into account the relative cost of living and the

inflation rates of different countries, rather than just a nominal gross domestic product

(GDP) comparison. The best-known and most-used purchasing power parity exchange

rate is the Geary-Khamis dollar (the "international dollar").

PPP exchange rates (the "real exchange rate") fluctuations are mostly due to market

exchange rates movements. Aside from this volatility, consistent deviations of the market

and PPP exchange rates are observed, for example (market exchange rate) prices of non-

traded goods and services are usually lower where incomes are lower. (A U.S. dollar

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exchanged and spent in India will buy more haircuts than a dollar spent in the United

States). PPP takes into account this lower cost of living and adjusts for it as though all

income was spent locally. In other words, PPP is the amount of a certain basket of basic

goods which can be bought in the given country with the money it produces.

There can be marked differences between PPP and market exchange rates. For example,

the World Bank's World Development Indicators 2005 estimated that in 2003, one United

States dollar was equivalent to about 1.8 Chinese Yuan by purchasing power parity —

much different than the nominal exchange rate that put one dollar equal to 7.6 Yuan. This

discrepancy has large implications; for instance, GDP per capita in the People's Republic

of China is about US$1,800 while on a PPP basis it is about US$7,204. This is frequently

used to assert that China is the world's second-largest economy, but such a calculation

would only be valid under the PPP theory. At the other extreme, Japan's nominal GDP

per capita is around US$37,600, but its PPP figure is only US$30,615.

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REFERENCES AND BIBLIOGRAPHY

• International Monetary Fund – Research Working Papers, statistics and Economic

Forecasts

• Reserve Bank of India – Publications

• The Central Intelligence Agency, USA – World Fact Book

• The World Bank Publications

• Goldman Sachs Study Reports

• The Hindu Daily

• NLI Research Institute, Japan

• Wiki Finance

• Nation Master

• Reuters India

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