Home / Opinion / Views /  Rupee trade settlement offers India structural benefits

International trade today is centred on what Gita Gopinath refers to as the ‘Dominant Currency Paradigm’ (DCP), in which the US dollar holds predominance as the source, destination and vehicle currency. The DCP has affected national exchange-rate policies by emphasizing the stability of the US retail price index and input costs. This, in turn, has produced a perpetual cycle in which dollar pegging at the national level drives more exporters, both domestic and international, to adopt dollar pricing, ultimately resulting in a macroeconomic complementarity for the use of the dollar in foreign trade and monetary anchoring. According to estimates, the dollar’s proportion of global invoices is currently 4.7 times more than its share of global imports. This gives a clear picture of the US dollar’s strength and indicates that changes in the US dollar value affect global trade prices and volumes, making the dollar’s value considerably more important than bilateral exchange rates for forecasting cross-country trade flows.

When it comes to India, 60% of all export-import payments are made in US dollars (and 86% in the case of imports). Even if an Indian exporter is paid in rupees, the settlement at the sovereign level is carried out in dollars. Dollar dominance also means that the rupee’s current slide is attributable more to dollar strength globally, even as the Russia-Ukraine conflict and ensuing trade sanctions imposed by the US have produced a trade setting that’s detrimental to India. We are reliant on Russia for sunflower oil, wheat and energy. In April and May 2021, India’s imports from Russia were worth $2.5 billion, or about $30 billion annually, a figure that experts say could rise to $36 billion yearly. So if India paid for all of its Russian imports in rupees, it would end up saving $30-36 billion in dollar outflows, in the best-case scenario. Even a partial rupee settlement window can mitigate the dollar outflow to a large extent.

Given these conditions, the Reserve Bank of India’s (RBI) 11 July 2022 decision to let domestic exim traders facilitate and settle invoicing and payments for international trade in rupees was highly welcome.

It is essentially a departure from the long-standing Foreign Exchange Management Act provision mandating final settlement in free foreign exchange. In practice, the rupee strategy would need foreign banks opening Vostro accounts in India, with settlements taking place instantly, allowing Indian exim dealers to settle rupee-denominated trade invoices using these Vostro accounts. The policy also provides the parties with some leeway by allowing advance flow management—done by using excess rupee balances for permissible capital and current account transactions in accordance with mutual agreements. In the Russian context, this provision for opening bank accounts is limited to Russian banks that are not on the US-Office of Foreign Assets Control (OFAC) sanctions list.

This policy measure has a clear motive. The move comes as the rupee falls to historic lows versus the dollar. Indeed, the sharp rise in global commodities, particularly oil for imports, has driven both our trade and current account deficits to worrying levels. By some projections, the current account deficit could touch 3% of GDP in 2022-23 despite a record increase in exports. A weakening rupee worsens the threat of imported inflation in India, since we depend on imports for about four-fifths of our annual motor-fuel demand. In this case, the policy would largely lower demand for foreign exchange for the settlement of current account-related trade flows.

It has economic and geopolitical implications. It has liberalized capital account convertibility even as it sought to relieve pressure on India’s dollar reserves. Capital account flexibility diminishes the function in trade of currency reserves. Further, the move could assist Indian exporters in collecting advance payments in Indian rupees from overseas clients. Even if a Vostro account is not pre-funded, foreign importers will have to buy rupees. The rupee payment method can be used to set off export and import transactions. Besides, the move could have a favourable long-term influence on regional nations wanting to trade with India, should New Delhi encourage them to use the rupee as a foundation currency for trade diversification in their settlement procedures.

In terms of international politics, the move is significant since it signals the beginning of more concerted attempts to settle payments in non-dollar currencies among Brazil, Russia, India, China, and South Africa (Brics), with other South Asian states looking keen too. In these turbulent times, with China and Russia forging alternative payment systems, it would support the Indian rupee’s position on the international stage.

RBI’s move on rupee-denominated trade was intended to reduce India’s trade deficit because India can more easily raise its proportion of Russian oil purchases at discount prices. A few issues do, however, still need clarity. Can exporters using the new rupee payment system claim tax refunds under different programmes, such as duty drawback and Remission of Duties or Taxes on Export Products (RoDTEP)? We must also watch the impact of volatility in capital flows on our home economy in the context of India’s absorption capacity. In conclusion, though, this de-dollarizing push holds potential as a risk management tool for RBI and also the promise of long-term structural benefits in India’s international trade.

Amar Patnaik is a member of the Rajya Sabha from Odisha, a former CAG bureaucrat and an advocate. 

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