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Will the rupee settlement plan be a game-changer for India?

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

As yet, the rupee is not a freely convertible currency

Internationalisation refers to the phenomenon of a national currency trading beyond its borders and actively used in the invoicing of trade and financial transactions, commodities, 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 internationalise the rupee and the payment disruptions caused by the Russia-Ukraine war offers a good opportunity to insist on export settlement in rupee, beginning with some of the smaller export partners.

And on Monday, in a step that can help take the rupee global, the central bank unveiled a mechanism for international trade settlements in rupees at market-determined exchange rates.

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

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

The surplus rupee balance Vostro accounts can be used for investments in government securities, payments for projects and investments and for export-import advance flow management.

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

Experts believe this might be aimed at facilitating easier trade with neighbours, particularly sanctions-hit Russia and forex starved Sri Lanka.

Ananth Narayan, Associate Professor – Finance at S P Jain Institute of Management and Research says this has potential to internalise rupee in the long-term. India can limit some hard currency outflows if Russia comes on board. Without free exit, other countries may 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 biggest oil supplier, replacing Saudi Arabia.

Barclays Chief India Economist Rahul Bajoria said this mechanism can be particularly useful for neighbouring countries.

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

The mechanism can also come in handy for trade with certain African and South American countries facing severe forex shortages.

Exporters meanwhile are seeking clarification on whether incentives applicable on exports where the payment is received in freely convertible currencies like the US dollar will be available in the rupee settlement mechanism too.

Biswajit Dhar, Professor, JNU adds India can have rupee-demoninated trade with sanctions-hit countries and it is up to diplomatic skills to get countries on board.

With Russia unable to access its foreign currency reserves, trade settlement in rupees can emerge as a win-win deal for both the countries as India ramps up its purchases of crude oil from the sanctions-hit nation. As for other countries, India’s diplomatic relations will determine whether they can be persuaded to adopt this medium for trade settlement.

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