The Reserve Bank of India (RBI) took steps last week to allow cross-border trade deals to be settled in rupees. A work in progress, but Indian banks can serve as custodians of funds in rupee-based overseas transactions, which is the gist of the matter. Foreign currency market developments necessitate immediate and long-term consideration of these actions, which need to be seen in both short-term needs and prospects for long-term growth.
Since RBI’s announcement of the internationalisation of the Indian Rupee, an Indian government official has made the first public statement on the matter. Dammu Ravi, Secretary for Minister of External Affairs, believes that commerce in national currencies, especially with Africa, has “immense scope.”
Let us have a look at the Current Mechanism
The transactions must always be conducted in a foreign currency if a corporation wants to export or import goods. The only exceptions to this rule are dealings with certain countries, such as Nepal and Bhutan. Consequently, in the case of imports, the Indian corporation must make payments in a foreign currency, most commonly in dollars but potentially including other currencies such as Pounds, Euro, Yen, etc. The Indian company is paid in a foreign currency if exports take place, which is subsequently exchanged into Rupees.
Addressing the Banking Settlements of International Trade in Rupees
Following the new structure, in order to settle trade transactions with any country, banks in India would open Vostro accounts (a correspondent bank holds another bank’s account; for example, SBI in India holds HSBC’s Vostro account) for trading with the correspondent bank or banks of the partner country. Importers from India will make their payments in rupees, which will be credited to the Vostro account held by the correspondent bank of the partner country. Similarly, exporters from India will be paid the proceeds of their exports in rupees using the funds that are available in the Vostro account of the partner country. Under the terms of this agreement, the Rupee (INR) may be used to denominate and invoice any exports and imports. The market may be allowed to set the exchange rate when converting from one country’s currency to the other.
One must look at the bilateral trade balance to understand how massive international trade deals in Indian rupees could be. In 2021, India’s trade with Russia totalled $3.3 billion in exports and $8.6 billion in imports. International trade can be handled in rupees up to $3.3 billion when exports and imports are equal. The Rupee may become challenging to settle foreign transactions after this point. However, the RBI has devised a workaround. The partner country’s rupee surplus balance may be utilised for capital and current account transactions permitted by mutual agreement. FEMA and similar statutory provisions apply to use the balance in Special Vostro Accounts for investment in Government Treasury Bills, Government securities, etc.
This brilliant political manoeuvring on the part of the Indian government will boost the expansion of international trade, with a particular emphasis on Indian exports. It will support the growing interest of the international trading community in the home currency. When India’s forex reserves are under pressure to save foreign currency, such commerce will not be subject to the purview of the forex movement. As a result, India will benefit from this trade. It is also possible that it will make it possible for Indian exporters to collect advance payments in rupees against their products from foreign importers. Foreign trade with countries like Russia and Iran, sanctioned by the United States and the European Union, will be more straightforward now that the Indian Rupee (INR) has been included in international trade settlements. Because of its potential to be used in international trade settlements, the Rupee may eventually become a globally recognised currency. It will have little impact on the Indian rupee currency in the immediate term. This move by the RBI should be carefully examined in light of the ever-changing nature of international financial transactions.
Global commodities prices have fallen since reaching a high in May this year. This makes sense in terms of India. July’s average price for crude oil was $106, nearly a 9 per cent decrease from June’s average price. However, this effect has been somewhat mitigated by the depreciation of the Rupee versus the Dollar, which can be attributed to the redistribution of money worldwide due to notable central banks boosting their interest rates. Since January, the outflow of funds from overseas portfolios has surpassed $30 billion. The Reserve Bank of India took different actions in addition to its market intervention to combat the Rupee depreciation. It liberalised Foreign exchange inflows and has opened up a channel via which trades can be settled in rupees.
This window can be used for two different things. It now enables India to take advantage of possibilities such as price reductions on oil from Russia. For instance, in April, India bought $1.3 billion of crude oil from Russia, making it the fourth largest source. When we last checked one year ago, Russia was not providing any crude imports. Settlement in rupees gives Indian companies the ability to sidestep Western sanctions, which are effective due to Western countries’ preeminent position in the international financial system. As a result of a shift in the make-up of global foreign exchange reserves, there is a good chance that, throughout the long run, there will be additional opportunities to internationalise the Rupee. The hold that the US dollar has is progressively eroding. It was at a level of 70 per cent twenty years ago, but it has since dropped to around 59 per cent. This pattern will continue as countries reduce the risk in their holdings. For example, the Bank of Israel intends to transfer some of the US dollars it now holds into the currencies of other countries, specifically Australia, Canada, China, and Japan. India must make the most of the opportunity that lies ahead. It is now up to the Government of India to make the necessary adjustments to relevant policies to complement the effort launched by the RBI.
According to onlookers, the Rupee is expected to gain strength in international currency markets due to the move. “Amid ongoing weakness in the rupee, the Reserve Bank of India announced steps that appear to be aimed at reducing demand for foreign exchange by promoting rupee settlement of trade flows,” said Rahul Bajoria, MD and Chief India Economist for Barclays. “The steps appear to be aimed at reducing demand for foreign exchange” “While these measures are not game changers right now, we see them as useful long-term steps that can permit more usage of Rupees in foreign commerce,” he added. “While they are incremental for now, we see these measures as useful long-term actions.”
The rising demand for the Rupee is a result of the worldwide popularity of UPI
The world’s 118.3 billion real-time financial transactions may inspire astonishment concerning technology. India processed 2.7 times as many instant payment transactions as China (18 billion in 2021) and 6.5 times as many as the United States, Canada, the United Kingdom, France, and Germany combined. The Unified Payments Interface (UPI) is India’s most popular digital payment system. It is connected to 323 different banks. UPI is trying to grow not only in India but also in other countries. Even though it has previously partnered with various institutions in Nepal, the United Arab Emirates, Japan, and China, the Reserve Bank of India (RBI) has stated that the National Payments Corporation of India (NPCI) will strive to develop the digital payment service as a route for making cross-border remittances. NPCI International, a foreign division of the National Payments Corporation of India (NPCI), has signed a memorandum of understanding (MoU) with Lyra Network, a French social networking platform, to adopt UPI and RuPay Cards in the country. This provides a boost to the digital payment ecosystem.
This cooperation will be a game-changer in the digital payments market, given the monthly transaction volume of 5.5 billion processed through the UPI in India. NPCI has already entered into a contract of this nature with PayNow, a business located in Singapore. Nepal’s payment system for digital transactions was first made available to the public in March of this year. Payments made using UPI are accepted in the countries of Bhutan, Singapore, Nepal, and the United Arab Emirates, among others. NPCI International is also exploring UPI services in the countries of West Asia and other European nations. These discussions are taking place in the United States.
There is also the opportunity to look at things from a different point of view. It is possible that India’s relationship with the United States could wane if it switched from the Dollar to the Rupee as its primary currency. Indirect effects may also be seen in the service sector, which derives most of its revenue from developed economies such as the United States and Europe. Despite this, India has a significant presence in the international trade sector and a significant reliance on the import of fossil fuels, edible oils, gold, and silver. It seems unlikely that the Indian Rupee will be used for invoicing as long as the value of the Rupee does not compromise the interests of exporting countries.