BackThe role rupee trade can play in external front stability
That our forex reserves fell more on account of asset revaluation than dollar sales by RBI should soften charges of excessive intervention but India remains vulnerable on the external front.
PremiumOne interesting point made in the Reserve Bank of India’s (RBI) credit policy was that 67% of the decline in foreign exchange reserves was due to “valuation changes". Simply put, this means that our forex reserves are held in various assets (cash or mainly bonds) like euros, special drawing rights (SDR), gold, yen, pounds and so on. With the dollar strengthening, the value of our overall vault has diminished. This is both good and bad news.
It is good news because there has been an argument made often that RBI is burning away reserves to defend the rupee, which cannot be infinite and is hence not a prudential approach. This follows from the fact that these reserves are built from capital inflows since we do tend to have a perpetual current account deficit, and hence using foreign direct investment, foreign portfolio investment, external commercial borrowings and non-resident Indian inflows to support the rupee is not a good idea. But if the depletion of reserves is not primarily due to the sale of dollars but valuation, this argument is weak.
The bad news is that if two-thirds of the decline in reserves is due to this external factor, then it exposes the helplessness of any country. All central banks like to keep diversified assets in their forex vaults. But if the dollar value falls even under ceteris paribus conditions, then vulnerability intensifies. Even gold has taken a hit with the dollar strengthening, which sends this component down independently, just like SDRs. If reserves were denoted in euros, say, then the picture wouldn’t be as gloomy.
But given that such valuation changes are beyond the control of any country, the concept of trade in local currency (i.e. rupees) becomes important. This is an idea whose time may have come, as countries have been exposed to a series of external forces that are not always economic. There is a need to have a strong forex arsenal for sure. When our balance-of-payments weakens, there will be a tendency for an outflow of reserves to maintain equilibrium. The currency will fall, which could hasten if RBI does not sell dollars to steady the rupee. One solution is to reduce outflows. Hence, allowing trade in rupees is a compelling option. The issue here is that for rupee trade to work, it has to be acceptable to counter parties. An oil company in Russia, say, will not have much use for rupees received unless it is converted to roubles by the government. The system that India has recently notified asks receivers to get their banks to maintain Vostro accounts for transactions, but their balances have to be invested in government bonds, which is not attractive for manufacturers that would prefer cash to financial investments.
This means that for any rupee trade facility to work, governments must be involved. If New Delhi signs agreements with say Russia, then trade will be in rupee-roubles. All roubles earned on exports will be channelled through the Indian government or banks that give rupees to exporters. The roubles earned will in turn be sold to those who import from Russia.
This will work where the volume of trade is significant between India and the other country, with a trade deficit at our end. For example, in 2021-22, India’s exports to China were $21 billion while imports were $73 billion. Hence, we had a deficit of $52 billion. A deal that would work is where the two countries agree to an amount of about $20 billion for which the exchange rate between the rupee and yuan would be fixed (through the dollar route presently). Our exports would be paid in yuan, which RBI could then sell to Indian importers who buy from China. This way, bilateral trade transactions would work.
Our second-largest export destination after the US is UAE, to which we export $28 billion and import $45 billion worth of goods. Here too, a predesignated amount could be agreed upon for rupee-dirham trade, with currencies sold to importers by the respective central banks. And in case the other currency is acceptable in third countries, like the yuan, then the volumes could go higher. This would encourage the formation of currency blocks across the world.
Since we have been talking of the internationalization of the rupee, countries with which we have a trade surplus, like Bangladesh and Sri Lanka, and those with which we have deficits, like Malaysia and Indonesia, can form a block where trade can take place in accepted currencies. This will reduce dollar dependence.
Will such arrangements solve our forex problem? Only to a certain extent, because while demand for dollars would come down, so would their supply through exports, as the raison d’être of bilateral currency trading is mutual acceptance. These arrangements would only address the issue of disruptions caused by the world economy’s dollarization. Today, as Western sanctions on Russia show, politics has taken over economics. Such bilateral currency arrangements will reduce dollar dependency and smoothen payment systems for trade, but may not address the challenge of dollar inflows.
The crux to addressing the currency and reserves challenge would lie in boosting exports in a globalized world where interlinkages are strong. Bilateral currency trading will address issues of valuation to an extent and help trading in a relatively non-dollarized environment. But, ultimately, fundamentals have to be strengthened to emerge stronger. There’s no other way out.
These are the author’s personal views.
Madan Sabnavis is chief economist, Bank of Baroda, and author of ‘Lockdown or Economic Destruction?’
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