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Imagine you are one of India’s leading software exporters. Your costs, mainly wages and salaries, are domestic and rupee denominated. Your customers are mostly in the US and Europe; hence your revenues are in dollars and euros. Would it not make sense to invoice your services in rupees, so both revenues and costs are in the same currency? That would give your business greater predictability in terms of cash flows and contracted values of revenues and costs. This is because fluctuations in exchange rates are more frequent and volatile than changes in salaries and domestic costs. Hence, the exchange-rate risk would be borne by your customer. It would be up to your customers to hedge it.

That would be swell, but you may ask, do domestic regulations really allow exporters to invoice in rupees? Yes, of course, and it has been allowed for many years. Then why do our exporters not invoice in rupees? The Reserve Bank of India (RBI) does not stop them. The main reason is that American customers will simply walk away. They don’t want to deal with currency risk, and in any case, there are no instruments to hedge their rupee risk available in that country. So, even the software giants of India have to swallow their pride and do dollar invoicing. This is the geopolitical reality of the almighty US dollar. As one famous US treasury secretary said, “The dollar is our currency, but your headache!" It is not just for Indian exporters. Dollar invoicing is a worldwide phenomenon. As much as 85% of India’s exports are invoiced in dollars, although only 15% of exports are meant for US shores. To add to exporter woes, dollar prices do not fluctuate much with exchange rates; they remain ‘sticky’. If domestic costs rise, then the exporter does not get compensated with a higher dollar price in invoices.

This global phenomenon of dollar invoicing in international trade and its stickiness has led to substantial dilution if not negation of the Mundell Fleming (MF) Paradigm of international exchange rates. The MF theory posits that a weaker domestic currency would lead to a commensurate increase in exports. But due to fixed (or sticky) dollar invoicing, the exporting country does not benefit. Countries like India suffer on the flip side too, since 97% of its imports too are invoiced in dollars. This has led to an alternative ‘Dominant Currency Paradigm’ explanation of international trade, a theory pioneered by Gita Gopinath and others. It explains the asymmetry in the impact of a weaker currency on domestic inflation between developing and developed countries. For the US, almost all its imports and exports are invoiced in dollars. To that extent, it does not have to worry about currency risk.

There is another reason that the Indian exporter does not want to invoice in rupees. That’s because the rupee inherently has a weakening bias, so there are chances of windfall gains from its fall, which cannot happen with rupee invoicing. Of course, the American customer is equally smart and squeezes the contract to factor in anticipated gains from a rupee fall. What explains rupee-invoicing reluctance for software applies to other exports too. It explains why 5-star hotels in India won’t quote prices in rupees to foreign tourists who seek good deals on the internet.

This backdrop of lack of progress in rupee invoicing despite plenty of policy nudges must be kept in mind when we evaluate RBI’s latest announcement. The one major relaxation it has given is that rupee proceeds of exports can be invested in domestic assets, i.e, government bonds. Earlier, these proceeds, which typically sit in Vostro accounts of correspondent banks, had to be immediately deployed. It is not clear whether this relaxation will make exporters rush into rupee invoicing. Since imports can now be paid in rupees, it is a big boost for Indo-Russia trade, of course. Discounted oil from Russia can be paid in rupees, which can in turn be used to pay for Indian exports to Russia. This is a clever way to get around de facto sanctions on trade with Russia. Some years ago, India had offered a rupee trade route for oil imports from Iran to get around American sanctions. Since dollar payments clear in New York, it was necessary to find an alternate settlement mechanism. Iranian suppliers were allowed to operate a special rupee account with UcoBank, which was also used to pay for India’s exports to Iran. The present move to expand rupee-denominated trade is a multilateral version of that bilateral arrangement.

Note that rupee invoicing is a far cry from internationalizing the currency. The latter would need significant steps toward capital account convertibility. It would need third countries’ willingness to settle payments and trade in rupees, and also hold the rupee as a reserve currency. That in turn requires the rupee to be much more stable than it is now. It would need unlimited access for the purchase and sale of rupees by any entity, be it onshore or offshore. The ability and readiness of foreigners to invoice in rupees is but a small step in a long journey. Undoubtedly, internationalization would help lower transaction costs for cross-border trade and reduce exchange risk, but it will also mean less autonomy of domestic monetary policy. India’s current parameters of bank asset quality, size of the fiscal deficit, inflation level and currency weakness imply that internationalization of the rupee is a bridge too far, and far from inevitable. Rupee invoicing, however, is a welcome shot in the arm for Indo-Russian trade, and will also help ease some depreciation pressure.

Ajit Ranade is a Pune-based economist

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