The Reserve Bank of India has recently allowed international trade settlement in Indian rupees. What does that mean for importers, exporters, and the Indian economy as a whole? We discuss this in today’s blog post.
The RBI on 11th July 2022 announced that all imports and exports from/to India could be denominated in Indian rupees. If you are wondering how the exchange rate with the trading-partner nations could work, the exchange rate will be market driven. To settle trade, Indian banks will need to open special Vostro accounts in the banks of the trading partner countries. This way, Indian importers who import goods from the trading partner countries could pay them back in Indian rupees. This payment would be credited to the special account in the trading partner country. The exporter from the trading-partner country would be able to convert the INR into local currency at the exchange rate determined by market forces. Same way, an Indian exporter will be able to receive payment from the overseas country in Indian rupees. This new system promotes the trading in the Indian rupee against the Dollar-dominated trade settlements.
The move couldn’t have come at the right time! India after almost a decade is staring at a possible Current Account Deficit level breach of 3% of the GDP this fiscal year. At the same time Capital account is also witnessing a lot of investment withdrawal owing to the monetary tightening policy embraced by the likes of the US Federal Reserve. Foreign Portfolio Investors (FPIs) have sold more than $30 billion worth of India. assets since the beginning of this calendar year. Also, the Indian rupee has been under tremendous pressure and is likely to breach the 1$=₹80 mark sooner or later. If somehow India manages to get its trading partners to accept the Indian rupee for trade settlement, it is going to help the burgeoning CAD and exchange rate a lot. But to what extent this is possible, it is still a question as of now! Here is why.
As of today, most of the global trade settlements happen in US Dollars. This is because the global nations perceive the US $ as the most stable currency that they can rely upon. According to a research note released by the US Federal Reserve, 97% of the trades in North and South America were settled in Dollars. These numbers are 74% in the Asia Pacific and 80% for the rest of the world. However, when the Indian importers have to make payments in US Dollars, they run into the risk of exchange rate fluctuations. This means that the Indian importer has to shell out more if the Indian rupee depreciates against the US Dollar. If the trade gets settled in Indian rupees instead, the trading-partner nation will bear the risk of this exchange rate risk against INR. Further, the US dollar is fully convertible, whereas an Indian rupee is only partially convertible. In such a scenario, not many countries would be willing to bear such a risk, one would think!
However, the present global situation augurs well for India to do trade settlements in Indian rupees with nations like Russia and Srilanka. Russia, facing global sanctions, could very well welcome the trade in INR. This benefits India since India’s ever-increasing energy imports from Russia can be settled in Indian rupees. Similarly, for Srilanka which is facing a severe economic and political crisis, India can support medicines and other essential items. Though India has been lending a helping hand to Srilanka, the prospect of trade settling in Indian rupees will make it much easier for India to help Srilanka. India has already tested this way of trade settlements with Iran.
All in all, though there are limited real-world use cases, trade settlement in the Indian rupee is a welcome move that helps India in certain special situations. The Indian importers and exporters being the immediate beneficiaries have welcomed the move.
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