In December 2022, India saw its first settlement of foreign trade in rupee with Russia – as part of the ‘International Settlement of Trade in Indian Rupee’ mechanism initiated by the Reserve Bank of India (RBI) in July last year.
Amid talks towards finalising a free trade agreement with India, Bangladesh is also considering the settlement of bilateral trade in Indian rupees.
Almost a year ago, the RBI’s report on currency and finance had said that the ‘internationalisation’ of the rupee is “inevitable.”
‘Internationalisation’ implies that the rupee can be freely transacted by both resident and non-residents, and can be used as a reserve currency for global trade. It involves promoting the rupee for import and export trade, and then other current account transactions followed by its use in capital account transactions.
The State Bank of India’s Ecowrap report had also recommended a conscious effort to ‘internationalise’ the rupee given the capital outflows from emerging market economies, including India, and currency depreciation. Thereafter, via a circular dated July 11, 2022, the central bank allowed the international settlement of trade in Indian Rupees for export and import of goods and services.
The decision was taken against the backdrop of a host of geopolitical tensions and global economic currents, including the US sanctions on the use of the dollar for transactions with Iran and Russia. And, amid the continuous weakening of the rupee, the idea was to promote growth of global trade with an emphasis on Indian exports and to buttress the increasing interest of the global trading community in rupee.
Prior to RBI’s announcement, SBI group chief economic adviser, Soumya Kanti Ghosh, had said, “The Russia-Ukraine war, and the disruptions to payments caused by it, is a good opportunity to insist on export settlement in rupee, beginning with some of the smaller export partners.”
The mechanism for international trade settlements in rupees at market-determined exchange rates means that Indian importers can now make payments in ‘rupee’ which will be credited to a Vostro account (special rupee accounts in Indian banks) of the corresponding bank of the partner country, while Indian exporters will be paid from the balances in the designated Vostro accounts.
The surplus rupee balance in the Vostro accounts can be used for investments in government securities, payments for projects and investments, and for export-import advanced flow management.
The reasons behind RBI’s intervention
The mechanism for international settlement in rupee might have been aimed particularly at facilitating trade with sanctions-hit Russia, possibly Iran, and forex-starved Sri Lanka. But most importantly, the move was expected to reduce the pressure on India’s forex reserves.
India is a net importer and the value of the Indian rupee has been declining consistently. The rupee was the worst performing Asian currency in 2022, witnessing a fall of around 10% against the greenback. Using the rupee for international trade transactions will help check the flow of dollars out of India and slow the depreciation of the currency albeit to a “very limited extent.”
Currently, Russia, Sri Lanka, and Mauritius have opened Vostro accounts. A potential rupee-dirham payment mechanism with Saudi Arabia and the UAE might begin as early as this month. India has proposed that these countries invest the rupee holdings in government securities.
Reports say that over three dozen countries have shown interest in trade settlement in rupee, and discussions are ongoing with the central banks of Tajikistan, Cuba, Luxembourg, and Sudan. Crude import from Russia has increased exponentially and India would wind up saving almost $30 billion in dollar outflows if all its Russian imports are paid in rupees. But even with a partial rupees settlement window, the dollar outflows can be significantly reduced.
Facilitating the rupee trade is also expected to spur exports to Russia, which dropped by 17% in the first half of this fiscal to $1.6 billion, majorly due to the delayed receipt of payments.
International trade settlements in rupee are expected to gradually contribute to the global acceptance of the currency, and later make it possible to repay loans taken from fund banks like the Asian Infrastructure Investment Bank.
What are the complications?
While the ‘internationalisation’ of the rupee may lower transaction costs of cross-border trade and investment operations by mitigating the exchange rate risk, it will lead to complications in terms of formulating the monetary policy.
International trade transactions between nations are shaped by various factors, such as political and economic relations, availability of goods, quality, competitive pricing, and exchange rates. For instance, the currencies of several countries like Bangladesh, Turkey and the UK have depreciated against the US dollar by more than 10%. Will Turkey, where Lira has depreciated almost 94% against the dollar, import more from India even if we decide to have the exchange rate fixed?
The dollar’s proportion of global invoices is currently 4.7 times more than its share of global imports, making the dollar’s value considerably more important than bilateral exchange rates for forecasting cross-country trade flows.
Therefore, the simultaneous pursuit of the exchange rate stability and a domestically oriented monetary policy will be more challenging, “unless supported by large and deep domestic financial markets that could effectively absorb external shocks”.
In addition to sophisticated financial markets, the most important prerequisite for the ‘internationalisation’ of a currency is price stability.
RBI’s report warns that the ‘internationalisation’ of the rupee can potentially limit the ability of the central bank to control domestic money supply and influence interest rates as per the domestic macroeconomic conditions.
The central bank’s deputy governor, T. Rabi Sankar, had said in October last year that these risks associated with the ‘internationalisation’ of the rupee are unavoidable if India wants to become an economic power. “If a substantial portion of its trade is in rupee, non-residents would hold rupee balances in India which would be used to acquire Indian assets. Large holdings of such financial assets could heighten vulnerability to external shocks, managing which would necessitate more effective policy tools,” he had said.
In the prevailing global atmosphere of trade protectionism and geopolitical rivalries, promoting invoices in rupee with various countries will not be an easy task. Indian private banks with an exposure in the US are worried about getting involved in trade transactions with Russia.
Efforts to “internationalise” the rupee, along with being an expression of its external credibility as the economy integrates globally, will be viewed as a move towards ‘de-dollarisation’ as part of the global campaign to decouple international trade from the US dollar.
Although from an Indian standpoint, the idea is not to challenge dollar dominance, however, the effort might indirectly affect the services sector for which we are dependent on the developed markets like the US and Europe.
For now India’s share in global trade is not significant enough and we are overwhelmingly dependent on the import of fossil fuels, edible oils, gold, silver, etc. making it an unlikely possibility for exporting countries to consider the Indian rupee as an invoicing currency, unless it suits their interests.
To make the rupee a highly tradable currency India must increase exports and imports, supported by critical reforms that include capital account convertibility, deepening financial markets, coupled with large financial institutions other than the RBI to manage the large-scale inflow and outflow of capital.
Vaishali Basu Sharma is an analyst of strategic and economic affairs. She has worked as a consultant with the National Security Council Secretariat for nearly a decade.