Will Rupee Settlement Plan Be A Game Changer For India?

In February last year, the Reserve Bank of India said that the emergence of the Indian rupee as an international currency was inevitable. According to the central bank, internationalization will reduce the transaction costs of cross-border trade by mitigating exchange rate risk but may also complicate the conduct of monetary policy.

The rupee is not yet a freely convertible currency

Internationalization refers to the phenomenon of a national currency being exchanged beyond its borders and actively used in the invoicing of commercial and financial transactions, raw materials and foreign exchange reserves.

And last week, SBI Group Chief Economist Soumya Kanti Ghosh said in a research note that the RBI should make a “conscious effort” to internationalize the rupiah and that payment disruptions caused by the Russian war -Ukrainian provide a good opportunity to insist on export settlement. in rupees, starting with some of the smaller export partners.

And on Monday, in a step that may contribute to the globalization of the rupee, the central bank unveiled a mechanism for settling international trade in rupees at market-determined exchange rates.

RBI’s decision means that Indian importers can now make payments in rupees, which will be credited to the Vostro special account of the correspondent bank in the partner country, while Indian exporters will be paid from the balances of designated Vostro accounts.

A vostro account is an account held in rupees by a local bank for a foreign bank.

Excess rupee balance in Vostro accounts can be used for investments in government securities, payments for projects and investments, and for handling anticipated import-export flows.

Russia’s war and subsequent economic sanctions from the West, such as the blocking of some Russian banks from the SWIFT financial messaging system, may have prompted the RBI to take this step.

Experts believe it could be aimed at facilitating trade with neighbors, especially sanctions-hit Russia and currency-starved Sri Lanka.

Ananth Narayan, Associate Professor – Finance at SP Jain Institute of Management and Research, says this has the potential to internalize the rupee in the long run. India may limit some hard currency outflows if Russia rallies. Without free exit, other countries might not find this mechanism attractive, he says.

India imported oil worth $5.1 billion in the three months to May from Russia, more than five times the value a year ago.

In fact, Russia has become India’s second largest oil supplier, replacing Saudi Arabia.

Barclays India’s chief economist, Rahul Bajoria, said the mechanism can be particularly useful for neighboring countries.

India’s trade with its neighbors and Russia stood at $169 billion in FY22, or 16.4% of the country’s total trade volume.

The mechanism can also be useful for trade with some African and South American countries facing severe currency shortages.

Meanwhile, exporters are seeking clarification on whether the incentives applicable to exports when payment is received in freely convertible currencies like the US dollar will also be available in the rupee settlement mechanism.

Biswajit Dhar, Professor, JNU, added that India can have rupiah-based trade with countries under sanctions and it is up to diplomatic skills to engage the countries.

With Russia unable to access its foreign exchange reserves, rupee trade settlement may become a win-win deal for both countries as India steps up its purchases of crude oil from the sanctions-hit country. As for other countries, India’s diplomatic relations will determine whether they can be persuaded to adopt this mode of trade settlement.

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