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India goes for global trade payments in rupees: What it means & challenges ahead

The Reserve Bank of India’s (RBI) order comes at a time when the rupee has crashed to record low levels against the US dollar in recent weeks.

HIGHLIGHTS

  • Last week, SBI proposed that RBI should make a “conscious effort to internationalise the rupee”
  • RBI has detailed the broad framework for cross-border trade transactions in rupees
  • The settlement of trade transactions under this arrangement must take place in rupees

The Reserve Bank of India (RBI) has announced that it is putting into place a mechanism for international trade settlements in rupees. The order takes immediate effect and the mechanism is designed to “promote growth of global trade with emphasis on exports,” the RBI said.

“In order to promote growth of global trade with emphasis on exports from India and to support the increasing interest of the 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 statement on Monday.

The RBI’s order comes at a time when the rupee has crashed to record low levels against the US dollar in recent weeks.

Last week, the State Bank of India (SBI) proposed that RBI should make a “conscious effort to internationalise the rupee”. The SBI in its “Research Ecowrap” stated, “The Russia-Ukraine war and the disruptions to payments caused by it, is a good opportunity to insist on export settlement in rupees, beginning with some of the smaller export partners.”

INTERNATIONAL TRADE SETTLEMENTS IN RUPEE: WHAT DOES IT MEAN?

The RBI has detailed the broad framework for cross-border trade transactions in rupees under the Foreign Exchange Management Act, 1999 (FEMA):

1. All exports and imports under this arrangement may be denominated and invoiced in rupees.

2. Exchange rates between the currencies of the two trading partner countries may be market determined.

3. The settlement of trade transactions under this arrangement must take place in rupees.

WHAT IT MEANS FOR IMPORTS AND EXPORTS

Indian importers undertaking imports through this mechanism need to make payment in rupees which must be credited into a Special Vostro account of the correspondent bank of the partner country, against the invoices for the supply of goods or services from the overseas seller or supplier.

Similarly, Indian exporters, undertaking exports of goods and services through this mechanism, must be paid the export proceeds in rupees from the balance in a designated Special Vostro account of the correspondent bank of the partner country.

RUPEE AS INTERNATIONAL CURRENCY

A currency is generally termed ‘international’ if it is widely accepted across the world as a medium of exchange for trade.

The US dollar is the most widely accepted currency for international trade, followed by the European euro.

Earlier in the 1960s, the rupee was accepted in gulf countries such as Qatar, the UAE, Kuwait, and Oman. India also had payment agreements with eastern Europe and the rupee was used as a unit of account under these payment agreements. However, in the mid-1960s, these arrangements were terminated.

CHALLENGES AHEAD

The rupee can be transformed into an international currency by making it a stable currency to enable international trade or by keeping it as an asset.

To simplify, we can say that the rupee needs to become a currency in which assets are held.

The rupee becoming an international currency would likely to reduce India’s trade deficit. The rupee will be strengthened in the global market. Other countries may start adopting the rupee as their trade currency.

However, there are challenges in internationalization of the rupee as a currency of trade.

“Internationalising the rupee is easier said than done. Increasing external trade denominated in rupee terms instead of the more popular currency — the US dollar — will be quite difficult,” Sandeep Bagla, CEO of Trust Mutual Funds, told IndiaToday.In.

“The rupee will have to be made fully convertible. Unless markets are deep with large financial institutions other than the RBI, large flows could lead to volatility in the value of the rupee, which could make monetary policy setting difficult for the central bank,” Bagla said.

In the short run, it would be difficult.

India needs to start exporting more to other countries. Also, India needs to become a manufacturer as that would significantly help the rupee become a currency of trade.

For example, on March 23 this year, Russian President Vladimir Putin announced that European countries would have to pay in Russian currency rubles instead of the US dollar or the euro, for all natural gas imports. Putin could make the demand because Russia supplies 40 per cent of the European Union’s natural gas requirements.

If the rupee is internationalised, then India will truly become self-reliant.

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