Explained: Settlement of International Trade in Rupees and Why RBI Does It

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  • RBI try to do it Rupee generally acceptable for trade by letting settlements be made in Indian currency, instead of US dollars.
  • RBI’s efforts will only pay off, if at all, in the long term and experts see nothing changing in the near future.
  • What exactly does it mean when RBI says international trade can be settled in rupees? We break it down here.

The Reserve Bank of India’s efforts to maintain the stability of the rupee and reduce the use of the US dollar – a decades-old habit that most countries seem unable to shake off – have seen a serious start with the central bank now allowing international trade invoicing in rupees.

“It is to facilitate greater trade in the rupee. Previously, invoicing in rupees was allowed, but it was not so popular because surplus rupees were not allowed to be reinjected into rupee assets. Now they are. For a currency to be globally acceptable, capital flows and trade must be liberalized hand in hand,” said Anindya Banerjee, Vice President, Currency and Interest Rate Derivatives at Kotak Securities, at Business Insider India.

But what does that mean exactly? We try to explain this in simple terms.

What is Rupee International Trade Settlement?

When countries import and export goods and services, they must make payments in a foreign currency. Since the US dollar is the world’s reserve currency, most of these transactions are made in US dollars.

For example, if an Indian buyer concludes a transaction with a German seller, the Indian buyer must first convert his rupees into US dollars. The seller will receive these dollars which will then be converted into euros.

Here, both parties involved have to bear the conversion costs and bear the risk of fluctuating exchange rates.

This is where trade settlement in rupees comes in – instead of paying and receiving US dollars, the invoice will be settled in Indian rupees if the counterparty has a Rupee Vostro account.

The move to allow international trade in rupees aims to facilitate trade with Sri Lanka, which lacks foreign exchange reserves, and Russia, which cannot make payments in US dollars due to Western sanctions.

What is a Vostro and Nostro account?

To accept payments in rupees, authorized dealer banks will be able to open special Rupee Vostro accounts. A Rupee Vostro account is an account of a foreign bank with an Indian bank in rupees in India.

For example, HSBC holding an account with State Bank of India in Mumbai branch denominated in rupees is called a Rupee Vostro account.

Foreign parties will be able to send and receive money from Indian exporters and importers through these Rupee Vostro accounts.

On the other hand, a Nostro account refers to the account of an Indian bank with a foreign bank in foreign currency in the foreign country. It is as if SBI held an account with HSBC in London, denominated in sterling.

Why does the RBI want to settle payments in rupees?

This move will help reduce India’s dependence on the US dollar. Experts Business Insider India spoke to suggested that while the move won’t have a huge impact in the short term, it will benefit the country in the long run. “We see little impact on the value of USDINR in the short to medium term. In the long term, it will displace some demand for rupees from the USD. But the impact of this USDINR will be very gradual,” Anindya Banerjee, vice president, foreign exchange and interest rate derivatives at Kotak Securities, told Business Insider India.

Sanctions against Russia due to its war on Ukraine, and the West subsequently cutting Russia off from the SWIFT payment system are likely one of the motivating factors behind this decision.

“The recent Ukraine-Russia crisis and the sanctions against Russia have been a real eye-opener for most countries now trying to reduce their dependence on the US dollar,” Heena Naik, research analyst – currency, Angel One told Business InsiderIndia.

Moreover, since India has a trade deficit – its imports are greater than its exports – settling trade in rupees will also save dollar outflows. At a time when the value of the Rupee is falling every week against the US Dollar, saving dollar outflows becomes even more critical for the RBI.

Bypassing the SWIFT payment system and paying for imports in rupees would also help India circumvent sanctions imposed on its trading partners – Russia being the latest and Iran another prominent example from the past.

How much will India save with this decision?

According to the latest trade data, India’s imports from Russia amounted to $2.5 billion in April and May. That cancels out at $30 billion, and experts suggest it could grow to as much as $36 billion a year.

In the best-case scenario, if India paid for all its Russian imports in rupees, it would end up saving $30-36 billion in outgoing dollars.

For context, the RBI recently spent $40 billion to keep the rupee stable, and it could spend another $40 billion.

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