Currency conundrum

Why in the News

The BRICS New Delhi Declaration records only incremental progress on local currency trade. Its paragraph on the subject acknowledges the efforts of various task forces and committees and offers no concrete proposal. The Declaration promotes local currency trade “while respecting national priorities and acknowledging that there is no one-size-fits-all approach”, which is the language of a member that wanted its reservations placed on record. India’s rupee trade with its BRICS partners is limited to the United Arab Emirates and Russia, and even those volumes are small. The tension is that India gains from being paid in dollars as an exporter and from paying in cheaper local currencies as an importer, and it cannot hold both positions indefinitely.

What is local currency trade settlement?

1. Definition: Local currency trade settlement is the invoicing and payment of a cross border transaction in the currency of one of the two trading countries, rather than in a third currency such as the dollar. The exporter is paid in a currency that one of the two governments issues.
2. Mechanism: The importing country’s bank credits the exporting country’s currency into a designated account held with a bank in the exporter’s country. The Reserve Bank of India (RBI) operationalised this for India in July 2022 through Special Rupee Vostro Accounts, which hold a foreign bank’s rupee balances for settling trade.
3. What it does not do: Settlement in a local currency changes the unit of account for a transaction and creates no new common currency and no shared central bank. The parties still have to agree an exchange rate and find uses for the balances that accumulate.

Where does India’s rupee trade actually stand?

1. Two partners only: Within BRICS, only the United Arab Emirates and Russia are engaged in rupee trade with India. The volumes involved are relatively small.
2. Russia’s surplus problem: Russia struggled to dispose of the rupees it was accumulating from its exports to India. A surplus holder that cannot spend or invest a currency has no reason to keep accepting it.
3. A partial opening: Some avenues have opened, with Russia importing petroleum products from India after Ukraine’s attacks on its refining capacity. That flow is small against the size of the bilateral trade imbalance.
4. A third currency as ‘local’: Another option is to treat any BRICS currency as local. India has already been using the UAE Dirham to pay for Russian oil, which sidesteps the dollar without using the rupee.

Why is this not a simple choice for India?

1. The exporter’s interest: India would prefer to continue being paid for its exports in dollars. A depreciating rupee means every dollar received converts into a larger rupee amount, and a country pushing exports wants to retain that advantage.
2. The importer’s interest: India is also a major importer, and it would prefer to pay in relatively cheaper local currencies. The two preferences point in opposite directions on the same policy.
3. The choice is deferred, not avoided: A country cannot indefinitely invoice its exports in one currency and its imports in another without its partners noticing the asymmetry. India will eventually have to settle which of the two interests governs.

Why does China’s share turn this into a question about the yuan?

1. Concentration of BRICS trade: China accounts for about two-thirds of all BRICS exports. Local currency trade across the grouping will therefore largely be trade in the yuan.
2. Political reluctance: Relations with China are thawing, and India would still be reluctant to conduct its business in the yuan. A settlement currency creates a standing dependence on the issuing country’s banking system and payment rails.
3. Why the general language matters: A grouping whose largest exporter issues the default settlement currency cannot offer a single formula that suits every member. The Declaration’s rejection of a one-size-fits-all approach is the recorded consequence of that arithmetic.

How does local currency trade differ from a BRICS currency?

1. Local currency trade: This is a bilateral settlement arrangement between two members, with no common issuer. India has been cautiously supportive of it.
2. A BRICS currency: This would be a shared unit requiring a common issuer, a reserve pool and agreed rules of issuance. India has been vocal in opposing it, largely because China would likely dominate such a currency.
3. The external cost: The United States President has threatened 100% tariffs on countries adopting a BRICS currency. India has taken a pragmatic approach in dealing with the United States and will not court such tariff threats lightly.
4. Different motivations across members: Countries such as Iran and Russia have pressing reasons to move away from the dollar, both being under extensive sanctions. India does not have a comparable compulsion, and the Declaration reflects that difference.

Challenges to local currency trade in BRICS

1. Limited convertibility of the rupee: The rupee is not fully convertible on the capital account, so a partner accumulating rupee balances has few assets to park them in. Eg. Russian banks accumulated rupee balances in Special Rupee Vostro Accounts that they could not deploy at scale.
   The Fix: Widen the permitted investment avenues for vostro balances, including government securities and corporate debt, so a surplus holder has a yield bearing use for them.
2. Structural trade imbalance: Settlement currency follows the direction of the surplus, and a partner running a persistent surplus with India will not accept rupees indefinitely. Eg. India’s oil imports from Russia are far larger than its exports to Russia.
   The Fix: Pair settlement arrangements with targeted market access for the partner’s goods, so the imbalance narrows rather than being financed.
3. Thin currency markets and hedging costs: Direct rupee to partner currency markets are shallow, so exchange rates are volatile and forward cover is expensive. Eg. Exporters settling in a partner currency carry a risk that a dollar contract would have passed to the market.
   The Fix: Build reference rate mechanisms and a bank led forward market for the main partner currency pairs before volumes are scaled up.
4. Secondary sanctions and payment channel risk: Banks handling settlement for a sanctioned partner risk losing access to dollar clearing, so large lenders stay out and the business shifts to small institutions. Eg. Several Indian banks limited Russia related settlement business rather than risk their correspondent relationships.
   The Fix: Route sanctioned trade through designated institutions with no dollar clearing exposure, keeping the wider banking system insulated.
5. Domestic monetary consequences: A widening use of the rupee abroad transmits offshore demand into the domestic money market and complicates exchange rate management. Eg. The RBI has intervened repeatedly to contain rupee volatility during periods of capital outflow.
   The Fix: Sequence internationalisation against clearly stated convertibility milestones, so the external use of the rupee grows with the depth of the domestic market rather than ahead of it.

Conclusion

India supports settlement in local currencies and opposes a common BRICS currency, and the New Delhi Declaration carries both positions without reconciling them. The reason is not drafting: the grouping’s trade runs through one member, and a shared settlement currency would hand that member the instrument. What India lacks is the compulsion its partners have, so its de-dollarisation is a hedge rather than a strategy. The unresolved point is whether India can keep collecting export receipts in dollars while asking its partners to accept rupees for the goods it buys.

Matching Previous Year Question

““BRICS acts as a powerful counterweight in global governance, actively amplifying the voice and influence of the Global South.” Explain the role of BRICS in projecting itself as an alternative to other groupings.”