The RBI’s efforts to preserve the stability of the rupee and lessen the usage of the US dollar, a decades-old habit that most of the world seems unable to break, has seen a serious beginning with the central bank now allowing international trade invoices to be issued in rupees.
“This is to promote greater commerce in rupees.” It was less prevalent when rupee invoicing was previously allowed since surplus rupees could not be invested in rupee assets. Now they are. Anindya Banerjee, VP of currency and interest rate derivatives at Kotak Securities, told Business Insider India that for a currency to be recognized on a global scale, both capital flows and trade must be liberalized.
What does rupee settlement for international trade mean?
Payments must be made in a foreign currency when importing and exporting goods and services. Most of these transactions are made in US dollars because it is the world’s reserve currency. Most of these transactions are made in US dollars because it is the world’s reserve currency. For instance, if an Indian buyer transacts with a German seller, the Indian buyer must first exchange his rupees for US dollars. These dollars will be sent to the vendor and converted to euros later. Both parties engaged in this situation must pay the conversion costs and assume the risk of fluctuating foreign exchange rates.
This is where the rupee trade settlement comes into play; if the counterparty has a rupee Vostro account, the invoice will be made in Indian rupees rather than paying and receiving US dollars. The move to permit international trade in rupees is intended to facilitate trade with Russia and Sri Lanka, whose foreign exchange reserves are running low and who are unable to accept payments in US dollars because of Western sanctions.
Authorized dealer banks will be allowed to create unique Rupee Vostro accounts to receive payments in rupees. A rupee Vostro account is a rupee account held by a foreign bank with an Indian bank in India. A rupee Vostro account, for instance, is one that HSBC maintains with the Mumbai branch of the State Bank of India and is valued in rupees.
Foreign parties will be allowed to send and receive money from Indian exporters and importers using these Rupee Vostro accounts. On the other side, a Nostro account is a foreign currency account between an Indian bank and a foreign bank in a foreign country. The situation is akin to SBI keeping a British pound account with HSBC in London.
Why does the RBI want to settle payments in rupees?
This action will lessen India’s reliance on US dollars. “In the near to medium term, we anticipate a modest change in the value of the USDINR.” In the long run, it will cause some USD demand to shift to rupees. Anindya Banerjee, VP of currency and interest rate derivatives at Kotak Securities, told Business Insider India that the impact of the USDINR will be extremely gradual.
One of the driving forces behind this move is probably the Western sanctions on Russia as a result of its war in Ukraine, which led to the West shutting off Russia from the SWIFT payments system. “The recent Ukraine-Russia conflict and sanctions on Russia were a great eye opener for most nations, who are now attempting to lessen their dependence on the US dollar,” says Heena Naik, research analyst for currency at Angel One.
Additionally, because India has a trade deficit—its imports exceed its exports—settling deals in rupees will prevent the outflow of dollars. Saving currency outflows becomes even more important for the RBI at a time when the value of the rupee versus the US dollar is falling every week. Rupee payments for imports would also allow India to get beyond the restrictions placed on its trading partners, the most recent of which is Russia; Iran is another notable example from the past.
The most recent trade statistics show that in April and May, India imported $2.5 billion worth of goods from Russia. This annualizes to $30 billion, and according to analysts, it might reach $36 billion. In the best-case scenario, India would wind up saving $30–36 billion in dollar outflows if it paid for all of its Russian imports in rupees. For reference, the RBI just spent $40 billion and might spend an additional $40 billion to maintain the stability of the rupee.
Why the RBI permitted the use of the rupee settlement mechanism in global commerce
The Reserve Bank of India (RBI) on Monday announced a plan for the nation’s traders to settle imports and exports in rupees, a move intended to facilitate trade with Russia, which is subject to several Western sanctions and is essentially cut off from standard cross-border payment platforms. This announcement came as the Indian rupee hit a record low of 79.45 against the dollar.
Allowing rupee settlements in global trade will help India promote exports and facilitate trading with sanctioned countries. Rupees, rather than dollars, may now be used to purchase Russian oil. As a result of intensified economic sanctions imposed on Russia by the United States, Europe, Australia, and Japan, India has cut its oil imports to profit from price drops. In India, where inflation has gone over the central bank’s target as oil prices have increased to approximately $130 per barrel, cheaper Russian crude can be advantageous since the contract appears to have been structured to enable a rupee-ruble trade.
For receipts and payments in rupees, exporters and importers can use a specific Vostro account connected to the correspondent bank of the partner nation. An account created by a domestic bank on behalf of a foreign bank is known as a “Vostro account.” The export partner may use the money in the rupee account to conduct business with anyone who takes rupees.
International trade settlement in Rupees and why RBI is doing it
The action by the central bank, which it justified by supporting increased global commerce and the rupee, comes as pressure on the Indian currency mounts in the aftermath of Russia’s invasion of Ukraine. The rise of the dollar, which continues to be supported by the demand for safe-haven assets and the Fed’s preference for monetary tightening despite the worsening GDP forecast, weighs down the rupee.
The dollar index reached its highest level since 2003, the 10-year US Treasury note regained the 3% mark, and commodities kept declining. A record $25.6 billion trade deficit was also recorded by India in June as a result of high gasoline prices and a generally healthy domestic economy.
With imports being bolstered by strong domestic demand and exports set to decline due to the potential of a global recession and the recent adjustment in commodity prices, India’s current account deficit/GDP is expected to remain at approximately 3%. Furthermore, the rupee would be under even more pressure as a result of capital outflows given the continuous global tightening of monetary policy and flight to safety.
In 2021–2022, commerce between India and Russia was $13.1 billion, and economists predict that the RBI will speed up business between the two nations. Several nations have imposed sanctions on Russia as a result of its invasion of Ukraine, including the US, which has denied Russia access to the dollar. Due to this, Indian businesses are now considering other methods of payment for imports to benefit from the cheaper prices of Russian goods.
“If India starts conducting business with Russia in this way, it could be able to pay for part of its oil imports in rupees. Rupee balances between Russian banks and the Indian banking system, which will be invested in Indian assets, will continue to be used to hold the positive trade balance (including government securities). As a result, India’s outflow of hard currency would be significantly decreased “Ananth Narayan, associate professor of finance at the S. P. Jain Institute of Management and Research, made a comment.
According to SBI research published earlier this month, the RBI should work to internationalize the Indian rupee so that non-residents may use it for trading and other activities. For instance, an importer from one country may use the rupee to purchase goods from another country. The RBI has to actively work to internationalize the rupee. According to SBI research, the Russia-Ukraine conflict and the resulting payment delays present a strong case for insisting on a rupee-based export settlement, starting with some of the smaller export partners.
Additionally, due to payment issues, trade with Russia has almost come to a halt since sanctions were put in place. Exporters have been waiting for a payment system with Russia to start delivering things like pharmaceuticals and food that are not subject to restrictions. A specific rupee Vostro account that Indian banks are permitted to operate on behalf of international partners is what a trade partner will receive or pay into if they accept to be billed in rupees.
“We expect payment challenges with Russia to lessen as a result of the trade facilitation mechanism implemented by the RBI.” Taking into account the euro-rupee parity, in particular, the measure would help lessen the danger of currency fluctuations. Mahesh Desai, head of the Engineering Export Promotion Council, stated, “We regard this as a first step towards 100% convertibility of the rupee.”
Currently, 60% of trade payments made by Indian companies are made in US dollars, followed by 5–10% in rupees, and the remaining balance is made up of foreign currencies. “The rupee hasn’t lost value versus all other currencies.” In actuality, it has gained ground on the currencies of the majority of important nations. It appears to be intended to reduce such currency volatility. In theory, this is a positive move since it allows importers and exporters greater options, according to Rahul Bajoria, managing director and chief India economist at Barclays.
Sakthivel, the head of the Federation of Indian Export Organizations (FIEO), stated that final payments have to be made in free foreign exchange, except for Nepal and Bhutan. This complies with the rules currently in effect under the Foreign Exchange Management Act. The final payment to all nations can now be made in Indian rupees, subject to RBI approval. Given the severe financial shortages that several African and South American countries are presently experiencing, the timing of the operation is opportune. Rupee invoicing would reduce foreign exchange risks because several currencies have fallen to new lows against the dollar, and the dollar has become extremely unpredictable.
Edited by Prakriti Arora