Explained: RBI’s decision to allow Indian Rupee trade settlements

The Reserve Bank of India has announced a new mechanism that will enable the settlement of international trade in Indian rupees. It’s the first time he’s done it. Why? There are several reasons.

First, as the central bank said, it will help promote growth in global trade with a focus on India’s exports. He also said the move would support the growing interest of the global trading community in the Indian Rupee.

Allowing trade settlement in rupees could help Indian exporters and importers to trade with some countries like Russia, which was banned from using a global currency like the US dollar after its invasion of Ukraine. Trade with India’s neighbors like Sri Lanka, which is in the midst of a currency crisis, could also be easier.

More importantly, it is a crucial decision in the context of a sharp depreciation of the rupee against the dollar. Over the past few months, amid a massive withdrawal of foreign institutional investors from India, the rupee has slipped towards the 80 mark. On Tuesday morning, the rupee touched 79.58 to the dollar. RBI’s latest move could help stabilize the rupee, if only to some extent.

How will the mechanism work?

Before putting this mechanism in place, licensed concession banks will need to obtain prior approval from the RBI’s Foreign Exchange Department.

All exports and imports under this arrangement can be denominated and invoiced in rupees. The exchange rate between the currencies of the two trading partner countries can be determined by the market. Licensed concession banks were allowed to open vostro rupee accounts (an account that a correspondent bank holds on behalf of another bank).

“Indian importers who undertake imports through this mechanism will make payment in rupees, which will be credited to the vostro special account of the correspondent bank of the partner country, against the invoices for the supply of goods or services from the seller / supplier Indian exporters who undertake exports of goods and services through this mechanism will receive the export proceeds in rupees from the balances of the special designated vostro account of the correspondent bank in the partner country,” said the RBI.

Indian exporters can also receive advance payment on exports from foreign importers in Indian rupee through the rupee payment mechanism.

The licensed dealer bank holding the special vostro account will need to ensure that the correspondent bank is not from a country or jurisdiction in the Financial Action Task Force (FATF) updated public statement on jurisdictions to high risk and uncooperative on which the FATF has called for countermeasures, the RBI added.

What are the experts saying?

Allowing rupee trade settlement is a good move and a step towards transforming the rupee into an international currency, said Abhishek Goenka, Founder and CEO of IFA Global.

“It would make the rupee more tradable globally in offshore centers. The acceptance of the rupee will increase,” Goenka said.

Since the invoice will be in rupees, the exchange risk will be transferred to the foreign buyer, he added.

Following Russia’s war on Ukraine, many countries imposed sanctions on Russia, including cutting off its access to the US dollar. As a result, many Indian companies trading with Russia and those looking to take advantage of the reduced price of Russian oil and other commodities have had to look for payment alternatives.

RBI’s decision to allow trade settlement in rupees will help in this regard. It could also facilitate wider trade with countries like Iran, which are under sanctions.

According to economists at Motilal Oswal Financial Services, this could help reduce the effectiveness of US sanctions imposed on Russia.

The RBI’s decision implies that it “aims to de-dollarize global trade and the Indian economy”, the economists said.

Deepak Shenoy, the founder of Capitalmind also wrote, “the internationalization of the rupiah receives a major kick”.

“It will help the rupiah against the US dollar because we don’t need so many dollars for our imports if Russia, Iran, UAE, Venezuela, etc. had to trade with us in rupees. This will reduce the pressure on the exchange rate,” Shenoy added.

However, this is likely to be a lengthy process, say economists at Motilal Oswal.

“Implementing this process will require careful deliberations with trading partners. The success of this measure will depend on how many of them are willing to exchange rupees,” they said.

It is also possible that if India requests payment for imports in rupees, the trading partner may also request payment for imports in their local currency. In such a scenario, the RBI might then have to hold foreign exchange reserves in a basket of currencies.

Capitalmind’s Shenoy also pointed out that for the measure to really take effect, the rupee really would have to be a “floating and tradable currency around the world”.

The Indian rupee is only partially convertible (freedom to convert the rupee into foreign currencies at market rates). While the rupee is fully convertible for current account transactions, trade settlement, for example, there are some restrictions for capital account transactions.

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