India’s rupee trade settlement mechanism, a means of using rupees instead of dollars and other big currencies for international transactions, is attracting interest from more countries.
More countries are interested
- Tajikistan, Cuba, Luxembourg and Sudan have begun talking to India about using the mechanism.
- They have shown interest in opening special rupee accounts, called vostro accounts.
- Opening of these accounts needs approval from the Reserve Bank of India.
- It has already been used by Russia following the imposition of sanctions on Moscow over the Ukraine war.
Rupee Settlement System for International Trade
- Banks acting as authorized dealers for such transactions would have to take prior approval from the regulator to facilitate this.
- All exports and imports under the invoicing arrangement may be denominated and invoiced in Rupee.
- The exchange rate between the currencies of the two trading partner countries may be market determined.
- Exporters and importers can now use a Special Vostro Account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees.
- These accounts can be used for payments for projects and investments, import or export advance flow management, and investment in Treasury Bills subject to Foreign Exchange Management Act, 1999 (FEMA).
- Also, the bank guarantee, setting-off export receivables, advance against exports, use of surplus balance, approval process, documentation, etc., related aspects would be covered under FEMA rules.
Benefits of such a mechanism
- Trade facilitation: This will also facilitate trade with countries like Russia which are facing sanctions.
- FOREX savings: India imports more than it exports so the country will also save foreign currency under the new arrangement.
- Rupee appreciation: The rupee is at a historic low against the dollar. It will also help stabilize rupee.
- Mitigating war impact: Payments had become a pain point for exporters immediately after the Russia-Ukraine war broke out, especially after Russia was cut off from the SWIFT payment gateway.
- Convertibility easing: We see this as a first step towards 100% convertibility of rupee.
- Energy security: It will also help buy discounted crude oil from Russia, which now accounts for 10% of all imported crude.
- Export promotion: As such, the new mechanism will help India promote its exports.
Which countries would prefer this system?
- War mongering Russia: For now, it looks like trade settlements in rupee will be limited to countries like Russia and Iran who are facing sanctions from the West
- Bankrupt Sri Lanka: SL is going through economic turmoil and India has been consistently extending lines of credit to SL.
- Immediate neighbors: Other countries may include immediate neighbors of India.
Rupees over Dollars: Why countries would prefer Rupees?
- At a very simplistic level, this is like two Indians deciding to use an alternative mode of exchange that they have come up with, instead of using rupees.
- In other terms, this is similar to the barter system.
- The main reason for countries to want to trade with India in rupees is this:
- USD has been going through a phase of strength against most currencies in the world
- Strong USD performance has essentially made imports expensive for most countries
- Sri Lanka, which is going through one of its worst economic crises in decades, is a glaring example of a country in which the economy has come to a halt due to a drastic fall in forex reserves
- While the Sri Lankan Rupee has declined over 83 percent against the US Dollar, its fall against the Indian Rupee has been lower at 70 percent.
- So instead of paying 83 percent more to make purchases in USD, Sri Lanka can pay in Indian Rupees and save some money.
Challenges
- Trade surplus countries’ preference: The question that RBI and the Indian government will have to answer is this – why would countries with a trade surplus with India want to trade in rupees?
- Negative trade balance: China had a $73-billion trade surplus with India in 2021-22 – that is, Indian imports from China exceeded its exports to China by $73 billion.
- Idle money lying useless: If China were to trade with India in rupees, it would have Indian rupees worth $73 billion (about ₹5.77 lakh crore) sitting idle in its Rupee Vostro accounts in an Indian bank.
- Few countries interested: Countries whose exports to India are more than imports, will not be too enthusiastic to trade in rupees, especially if the difference is huge as in the case of China.
