RBI's gameplan for conducting international trade settlements in rupees

As the rupee falls against the US dollar due to global uncertainties, the Reserve Bank of India on Monday introduced a rupee settlement system for international trade. This move will help the central bank to save some foreign exchange reserves and arrest the plunging domestic currency.

“In order to promote the growth of global trade with an emphasis on exports from India and to support the increasing interest of the global trading community in INR, it has been decided to put in place an additional arrangement for invoicing, payment, and settlement of exports and imports in INR,” RBI said in a statement.

The RBI said that all exports and imports under this arrangement may be denominated and invoiced in rupees (INR).

The order takes immediate effect, and the mechanism is designed to "promote the growth of global trade with an emphasis on exports," the RBI said.

Exchange rates between the currencies of the two trading partner countries may be determined, according to India's central bank.

Let's look at how exactly this process works and to what extent it will help the Indian rupee.

Why the rupee settlement system

Each country has a two-way monetary system, with one system used for domestic transactions and the other for international transactions. For example, the rupee is used as a medium of exchange in India, which means that goods and services are purchased and sold in rupees, and if India wants to import something from another country, it must pay in foreign currency (USD). Because the US dollar is a world reserve currency. To facilitate global trade all currencies are pegged to US Dollar.

At present currencies around the world were being pushed down by the dollar as countries sought to combat inflation by raising interest rates at the risk of entering a recession. Major global currencies are down between 5 and 17% since the start of 2022. The Indian rupee has dropped more than 6% against the US dollar and it is marching towards 80/dollar,  this resulted in a high trade deficit in June.

The trade deficit in the June quarter jumped to a record $70.8 billion, way above that of $31.4 billion in the same quarter last fiscal, according to the provisional data released by the commerce ministry on Thursday.

The country’s merchandise exports rose 23.5 per cent in June, while imports increased 57% on the back of elevated global commodity prices

If the trade deficit rises further, it will lead to more dollar outflows and will add more pressure to the rupee at a time when foreign investors are selling in Indian equity markets. Furthermore, a weaker currency raises the cost of imports and increases inflationary pressure.

However, this international settlement in rupees will allow RBI to save some dollar outflows, which will then be used to defend the rupee against the dollar in the Forex market.

For context, RBI has spent $41 billion of its reserves since February this year defending the rupee, Barclay's said in a report.

Moreover, this mechanism, which can be kicked off without delay with Russia, will lead to annual savings of around $30-36 billion, according to ET. Currently, India's imports from Russia amounted to about $2.5 billion each in April and May—$30 billion on an annual basis. Some analysts expect this to swell to a monthly average of $3 billion over the fiscal year, or $36 billion in all.

India is importing large quantities of crude oil from Russia at a discounted rate, and a mechanism to work out payments that bypass the US dollar was crucial. This arrangement also gives Russia access to a big market and liquidity amid the Ukraine conflict.

Meanwhile, as per the PTI report, since the beginning of the Russian-Ukraine war, India's share of Russian oil imports has increased and now accounts for 10% of all crude bought from overseas. Prior to the Ukraine war, Russian oil accounted for only 0.2 per cent of India's total oil imports.

How does this work?

Under this trading mechanism, Indian exporters will be paid in Indian rupees for their exports to other countries instead of standard international currencies such as dollars or euros.

For settlement of trade transactions with any country, banks in India may open Special Rupee Vostro Accounts of correspondent banks of the partner trading country. Indian banks need prior approval from the RBI to act as correspondent banks.

Indian importers undertaking imports through this mechanism shall make payment in rupees which shall be credited into the Special Vostro account of the correspondent bank of the partner country, against the invoices for the supply of goods or services from the overseas seller.

Indian exporters, undertaking exports of goods and services through this mechanism, shall be paid the export proceeds in rupees from the balances in the designated Special Vostro account of the correspondent bank of the partner country.

The balance in the special Vostro accounts can be used for payments for projects and investments, investments in treasury bills and government securities, RBI said.

India has tried this before

In 2014, India and Russia agreed to make payments through the rupee-rouble trade after India faced a US sanctions threat over a defence deal with Russia.

A rupee-rial payment mechanism, however, had successfully worked in India’s trade with Iran when economic sanctions were imposed on the country by a number of Western nations in 2012.

India successfully used the mechanism for partly paying for its oil purchase from Iran. This worked well for several years till the Trump regime placed product-specific sanctions on the oil trade with Iran and India stopped its purchases from the country.

Moreover, major Asian countries are trying to end the US dollar dominance in international trade. The dollar remains the world's top reserve currency, but its dominance has eroded to some extent. The greenback accounted for just under 60% of allocated reserves at the end of the first quarter of the 2022 calendar year, down from 65% in the same period in 2016, the FT reported, citing IMF data over a week ago.

Going forward, experts believe that this decision will assist to relieve some of the pressure on the rupee and it also increases rupee investments in domestic asset classes such as bonds and equities.

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