The Indian central bank seems to have hit multiple birds with one stone with this one stroke – preserving Forex, stabilising INR, enhancing liquidity and attempting to increase its acceptability as a global currency
The Reserve Bank of India’s (RBI) decision to allow international trade settlement in Rupee is a welcome one and has far reaching consequences in promoting the India Rupee as a global currency. The move is intended at reducing the dependence on US Dollar-denominated transactions.
The trigger might have been the ongoing Russia-Ukraine conflict which has resulted into widespread sanctions against Moscow by the US and other western powers.
“In order to promote growth of global trade with emphasis on exports from India and to support the increasing interest of global trading community in INR, it has been decided to put in place an additional arrangement for invoicing, payment and settlement of exports/imports in INR,” the RBI said in a circular.
With this one stroke, the Indian central bank has hit multiple birds with a single stone. One, the transactions in Rupee will ensure that large amount of forex (foreign exchange) reserves do not leave the country in a jiffy. India’s import bills are high largely on account of crude oil and gold imports (the government has also recently increased the import duty on gold after the country reported whopping import numbers in May). It is pinching all the more now with the US Dollar index going ballistic against all major currencies, including the INR. It is to be noted that the rupee has still held its ground against most other major currencies, and in fact has done better.
Dollar has been strengthening because of looming fears of global recession forcing people to hedge their losses by either buying USD or holding it.
Another important benefit is that it will mitigate the fall in the Indian Rupee against the US Dollar. However, strength or weakness is also linked to maintaining foreign exchange reserves.
The third important reason is to improve the liquidity situation which has got impacted significantly because of the sanctions on Russia. It is an attempt to bypass the hurdles created because of ban on Moscow on using SWIFT – the international payment system. Several media reports suggest that transactions between Russia and its trading partners have been severely hit because of the sanctions.
The fourth and equally important reason is to increase acceptability of Rupee as global trading currency. It may be clarified that by global trading currency, it means bilateral or multilateral transactions that involve trade with India.
A country which imports or exports has to do transactions in a foreign currency and USD is the international reserve currency. For example, if an Indian buyer makes an order for goods with Belgium, he must make payments in USD in accordance with the current exchange rate with 1 USD. The Belgium exporter who receives payment receives it in USD which is then converted into Euro.
While Rupee-denominated trades were done earlier also, it was limited. The RBI’s decision to liberalize Rupee trade is in view of the problems prevailing in Sri Lanka and Russia. In the former case, the island nation has become bankrupt and may not be able to pay in Forex. As for Russia, payments cannot be made in USD amid the sanctions imposed by the US.
Payments can be made by India or businesses back home or received by it by another country or businesses in that country if there is Rupee Vostro account.
To settle trade transactions with any country, banks in India will open Vostro accounts – an account that a correspondent bank holds on behalf of another bank.
The move may not show an immediate impact but is being seen by many as a positive and one that will yield long term benefits.
A Business Insider report suggested that Indian imports from Russia stood at USD 2.5 billion in April and May, and will annualize to USD 30 billion.
Meanwhile, the RBI recently spent USD 40 billion in keeping the Rupee stable. This means that rupee-denominated trade could be used to offset outflows and preserve the foreign exchange reserves.
The trading partners run the risk of currency fluctuations and with the trade now being allowed in Rupee, exporters will stand to benefit as the final settlement will be done in rupees.
The first goal must be to give a foothold to rupee-denominated transactions in Asia and especially in the country’s neighbourhood and gradually scaling its reach.
Many countries are facing problems with their forex reserves and we are seeing China now jumping to take advantage of the situation. It is now working towards making Yuan a global currency.
India is a growing economy which has strong fundamentals and huge potential, and increasing the clout of its own currency might take its own time. Nevertheless, the journey has begun.