Rupee trade with few nations may start, internationalisation will take time

Rupee trade with few nations may start, internationalisation will take time

India is negotiating with a few countries to settle trade in the rupee to get a step closer to the internationalisation of the currency, a far cry at the moment.

Negotiations are on with Russia, Cuba and Sudan among others to do so. Officials are hopeful that Saudi Arabia, United Arab Emirates and Luxembourg would also come on board to have this kind of arrangement. Exporters also want a similar arrangement with Sri Lanka, given the forex crisis there.

The Reserve Bank of India (RBI) on July 11 unveiled a rupee settlement system for international trade. The move was aimed at promoting the growth of global trade with an emphasis on exports and imports from India and to support the increasing interest of the global trading community in the Indian Rupee.

Exporters and importers can use a special Vostro account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees.

RBI said that all exports and imports under the invoicing arrangement may be denominated and invoiced in rupee, while the exchange rate between the currencies of the two trading partner countries may be market determined.

Besides, the central bank said that the special Vostro accounts can be used for payments for projects and investments, import or export advance flow management, and investment in government treasury bills, subject to Foreign Exchange Management Act, 1999 (FEMA).

According to the mechanism finalised by the RBI, banks of partner countries can approach authorised dealer (AD) banks in India for opening special rupee Vostro accounts. The AD bank will then have to seek RBI’s approval with details of such an arrangement. It will also have to ensure that the foreign bank is not from a country on which the Financial Action Task Force has called for countermeasures and that the country does not fall under the FATF public statement on high-risk and non-co-operative jurisdictions.

Clarity would emerge once the RBI comes out with guidelines for the facilitation of the mechanism.

Months after that, UCO Bank and YES Bank partnered with a few Russian banks to facilitate trade settlement in Indian rupees. 

Earlier, banks had raised concerns over the new international trade settlement in the rupee, fearing that the facilitation of such a mechanism could result in them facing the ire of economic sanctions by the West.

Large banks with overseas operations had sought clarity and assurance from the RBI that they will not be targeted with sanctions for facilitating rupee trade with a sanction-hit country such as Russia.

However, the government allayed banks’ concerns about sanctions by Western nations, saying if they steer clear of sanctioned items, entities, and banks, they won’t be affected.

Earlier the government’s demand was that the Indian banks carry out rupee trade with all banks, including sanctioned banks. But banks in India expressed their concerns that they have challenges at the international level. The government understood their concerns. Now settling international payments in rupee will be done purely with non-sanctioned entities.

The present payment mechanism is a shift from earlier such arrangements, like the one with sanction-hit Iran, which involved banks facilitating the settlement of international trade that did not have business in the sanctioned nation.

The Centre is of the view that the rupee settlement mechanism is not just targeted for trade with countries like Russia, but more of a statement from the sovereign for the internationalisation of its currency in the long term. This would substantiate India’s efforts towards the inclusion of the rupee in the IMF’s currency basket.

While in the short term, as India is witnessing a slowdown in demand from its key export markets — United States and Europe — amid fears of a recession, the department of commerce hopes that the rupee trade arrangement will boost trade with sanctions-hit Russia.

India’s dependence on cheap or discounted Russian crude oil has also been on the rise since March. In the April-June quarter, Russia became the third-largest crude oil supplier to India, after Iraq and Saudi Arabia, government data showed.

India imported goods worth $4.23 billion in June from Russia, up 6.8 times as compared to last year.

A delegation from Cuba, including officials from its central bank, met Indian government officials and banks last month to discuss bilateral trade and settlement using the RBI’s payment mechanism in rupee.

Since the Cuban nation has opened up its economy and is looking to implement reforms to attract investments from India, Cuban banks have evinced interest in opening special rupee Vostro accounts (SRVAs) with Indian banks.

The move is an effort by the Centre to lay the groundwork for the central bank’s new framework for trade settlement in the rupee, pushing for the local currency’s internationalisation.

The meeting was held at the direction of the Department of Financial Services under the Ministry of Finance.

Similar efforts are being made with Sudan.

However, the internationalisation of the rupee could happen if there is wide acceptance of the Indian currency in larger comity of nations.

Says Bank of Baroda chief economist Madan Sabnavis," True internationalization of any currency is when acceptance is not based on bilateral agreements but usage by two third parties. For example, if Russia and Iran agree to trade in rupees, then the Indian rupee becomes international."

Now if India talks to a few countries which agree to trade in rupees, they need to be important players in our trade basket, he said.

"Ideally we should be importing more than we export for India to gain. We import more from Russia than we export. Hence, we can partly pay for Russian oil with rupees, which they use to buy goods from India. They will not go beyond this level as the rupees will be of no use to them," Sabnavis said.

Therefore, trade relations need to be understood for this to work.

"For example, Cuba has hardly any trade with India given the distance which increases transport costs that erodes competitive advantage for both countries. Here it will not matter at all," Sabnavis pointed out.

Unless the USA, EU and other developed countries accept rupees, only then will local currency trade work, he said.

Internationalisation of the rupee means the currency can be freely transacted by both residents and non-residents, and be used as a reserve currency for global trade.

This would require full convertibility of the rupee for which India has adopted a gradual approach. As a policy, India has followed a gradual and cautious approach in opening up the capital account.

The capital account is being progressively liberalized in accordance with the evolving macroeconomic conditions and requirements of the Indian industries, individuals and financial sectors.

RBI in its Currency and Finance report last year said that the internationalisation of the rupee is “inevitable” but that would complicate monetary policy.

Internationalisation can lower transaction costs of cross-border trade and investment operations by mitigating exchange rate risk, but “makes the simultaneous pursuit of exchange rate stability and a domestically oriented monetary policy more challenging, unless supported by large and deep domestic financial markets that could effectively absorb external shocks”, the RBI report had said.