Explained: Why RBI Allowed Rupee Settlement System For International Trade

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NEW DELHI: Amid the Indian rupee touching a record low of 79.45 against the dollar, the Reserve Bank of India (RBI) announced on Monday an arrangement allowing traders in the country to settle imports and exports in rupees, a measure aimed at facilitating trade with Russia which faces a wide range of Western sanctions and is virtually cut off from cross-border payment platforms standard.
The decision to allow rupee settlements for international trade would help India promote exports and facilitate trade with countries under sanctions. The rupee can now be used to pay for Russian oil instead of the dollar. India increased its oil imports to take advantage of lower prices after the United States, Europe, Australia and Japan piled economic sanctions on Russia. Given that the arrangement appears to have been made to allow for a rupee-ruble swap, cheaper Russian crude may help India, which has seen inflation beat the central bank’s target as oil climbed to nearly $130 a barrel.
How does the new mechanism work?
Under this mechanism, exporters and importers can use a special vostro account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees. A Vostro account is an account opened by a bank in its home country on behalf of a foreign bank. Funds in the rupee account can be used by the export partner to trade with anyone who accepts rupees.
Indian exporters can also receive advances on exports from foreign importers in Indian rupees through this mechanism. Banks must obtain approval from the Foreign Exchange Department of the Reserve Bank of India to conduct such transactions. Moreover, before allowing such receipt of down payment on exports, Indian banks should ensure that the funds available in these accounts are first used for payment obligations arising from already fulfilled export orders/ pending export payments.
The move comes at a time when the rupee has hit record highs
The central bank’s move, which it said was to promote growth in global trade and support growing global interest in the rupee, comes amid mounting pressure on the Indian currency following the invasion of Ukraine by Russia. The rupiah continues to be weighed down by the strengthening greenback, continuing to benefit from safe-haven demand and the Fed’s monetary tightening bias despite the weakening growth outlook. The dollar index reached their highest level since 2003 (around 107.79) while US 10-year yields returned to the 3% mark while commodities continued to fall.
Additionally, high crude prices and relatively strong domestic demand widened India’s trade deficit to record highs of $25.6 billion in June. With imports supported by buoyant domestic demand and exports likely to fall due to global downside risks and the recent correction in commodity prices, India’s current account-to-GDP deficit is expected to remain at 3%. Additionally, capital outflows are likely to continue given the continued tightening of global monetary policy and the flight to safety, which will put further pressure on the rupiah.
Rupee trade will facilitate trade with Russia and prevent the fall of the rupee
The RBI mechanism should help importers and exporters avoid rules that prevent the use of a global currency such as the US dollar for trade with certain countries. After Russia attacked Ukraine, several countries imposed sanctions on Russia, as a result of which Indian companies needed alternative payment methods for imports.
According to Madan Sabnavis, Chief Economist at Bank of Baroda, “Setting international trade in rupees will provide a solution for such transactions with countries like Russia which are outside the SWIFT system. This will promote trade, especially imports , for India”. The critical part however will be the determination of the exchange rate which will be decided by the market.” Since India imports more than it exports, the country will save foreign exchange under the new arrangement. Under circumstances Normally, INDIA would have had to pay Russia in dollars for its oil purchases, which can now be done via the rupee-ruble route.
India’s trade with Russia stood at $13.1 billion in 2021-22, and experts believe the RBI would speed up transactions between the two countries.
Russia’s attack on Ukraine saw several countries impose sanctions at the first, with the United States cutting off Russia’s access to the dollar. This has prompted Indian companies, seeking to take advantage of falling Russian commodity prices, to consider alternative payment methods for imports.
“If India starts converting trade with Russia this way, it can potentially pay for some of its oil imports in rupees. The balance of trade – in favor of Russia – will remain as the rupee balances of Russian banks with the Indian banking system, to be invested in Indian assets (including government securities). This would significantly mitigate hard currency outflows from India,” said Ananth Narayan, associate professor of finance at the SP Jain Institute. of Management and Research.
The case of the internationalization of the rupee
Point to note: An SBI report earlier this month suggested that the RBI should make an effort to internationalize the Indian currency so that non-residents can then use the rupee for trade or other transactions.
For example, an importer from a particular country can source items from another country using the rupee. “The RBI should make a conscious effort to internationalize the rupee. The Russian-Ukrainian war and the resulting payment disruptions provide a good opportunity to insist on settling exports in rupees, starting with some of the smaller export partners,” the SBI report said.
In March 2022, Soumya Kanti Ghosh, the group’s chief economic adviser, SBI had stated that “the hegemony of the dollar is likely to continue over the coming decades, notwithstanding the alternative settlement mechanism envisaged by some nations, circumventing Western sanctions in as covert talks gain momentum for rupee-ruble or yuan-ruble settlements globally, with some enthusiasts also betting for gold settlements.”
And since the sanctions were imposed on Russia, trade has virtually come to a standstill with the country due to payment issues. Exporters are waiting for a payment mechanism with Russia to start shipping goods that are not subject to sanctions, including pharmaceuticals and food. If a trading partner agrees to invoice in rupees, they will receive or make payments to a special Vostro account in rupees which Indian banks have been authorized to open on behalf of foreign partners.
“Thanks to the Trade Facilitation Mechanism introduced by the RBI, we see that payment issues with Russia are easing. This move would also reduce the risk of forex fluctuation, especially in relation to the Euro-Rupee parity. We see this as a first step towards 100% rupee convertibility,” said Mahesh Desai, Chairman of the Engineering Export Promotion Council.
Currently, 60% of trade payments from Indian companies are denominated in US dollars, while 5-10% in rupees and the balance in other currencies. “The rupee has not weakened against all currencies. In fact, it has strengthened against the currencies of most major countries. It seems that this is intended to curb the volatility of this currency. In principle, this is a good step as it gives more flexibility to importers and exporters,” said Rahul Bajoria, managing director and chief economist for India, Barclays.
According to A. Sakthivel, Chairman of the Federation of Indian Export Organizations (FIEO), under the existing provisions of the Foreign Exchange Management Act, final settlements must be made in free foreign currencies, except for Nepal and Nepal. Bhutan. Now, if the RBI approves, the final settlement for all countries can be in Indian Rupee. The move comes at a good time as many countries are facing huge currency shortages in Africa and South America.
Invoicing in rupees would reduce currency risks as the dollar had become extremely volatile and several currencies hit new lows against the dollar.
Other Measures Taken by the RBI to Support the Rupee
Last week, RBI announced a series of measures aimed at improving currency flows and dampening the value of the rupee, including allowing foreign investors to buy short-term corporate debt and opening up more securities. state on a fully accessible way. It also announced the exemption from maintaining the CRR/SLR on additional deposits and the removal of the interest rate cap on these deposits.
With agency contributions
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