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RBI says yes to settling international trades with the INR.

By Shrestha Saha

14th Jul 2022

4 mins read

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The Indian rupee fell to a new historical low of Rs 79.84 against the US dollar. The Euro's setback has contributed significantly to the dollar index's rise, with the safe-haven attractiveness of the US dollar also attracting investments amid development concerns. The United States' inflation rate is 9%, the strongest in four decades. According to the IMF's chief, there are signs leading to a worldwide recession as well.

Amidst the prediction of a global recession, The Reserve Bank of India announced that trade settlements between India and other countries like Sri Lanka and Russia will begin trading immediately in India's domestic currency, the Indian Rupee (INR). While the move is expected to primarily benefit the trade with Russia, it is also expected to help limit dollar outflows and therefore reduce rupee depreciation to a "very limited degree."

What is the new rule about?

It is for global trade, and the process will aid in the settlement of such trade in the Indian Rupee. The new mechanism enables the billing, settlement, and payment of imports and exports to happen in the INR.

According to the RBI, this method was formed to promote international trade expansion, with a focus on Indian exports, and to support the growing interest of the global trading community in the Indian rupee.

How were international trades settled until now?

Up until recently, global trade (except with Nepal and Bhutan) had to be settled in fully convertible currencies such as the Sterling Pound, Yen, US dollar, and Euro under RBI exchange control regulatory requirements. For imported products, Indian companies must pay in foreign exchange. In the case of exports, the Indian company gets payment in foreign exchange, which it then converted to rupees.

Why now?

This step by India's central bank comes amid increased pressure on the Indian currency as a result of the Russia-Ukraine dispute and imposed sanctions on certain countries by the  European Union (EU) and the United States. Following the Russia-Ukraine dispute, for example, several nations imposed sanctions against Russia, leaving Indian companies in need of alternate payment solution methods for imports.

There's another reason as well.

India's forex reserves were at $588.3 billion as of July 8, a safe number. It was enough to cover roughly 10 months of imported goods. Having said that, the Reserve bank of India has been using the fund to assist the falling Indian rupee, which it does by selling USD.

How will the model function?

To settle commercial transactions with any nation, Indian banks will open Vostro accounts (a Vostro account is an account that a correspondent bank holds on behalf of some other bank — for instance, HSBC Vostro account is held by HDFC in India) of the partner country's correspondent financial institution for transactions. Indian importers can deposit rupees into such accounts to pay for their purchases. These import earnings will be used to pay for Indian exports in Indian rupees.

This was when India was experiencing huge outflows of FPIs and record trade imbalances. The country's trade deficit was $25.63 bn in June 2022. Perceiving which way the wind was blowing, the Reserve Bank of India  recently stated a few measures to maintain and even boost the forex reserves.

The RBI permitted banks to increase interest rates on non-resident Indians' international -currency holding accounts. It increased the immediate external commercial borrowing (ECB) limit to $1.5 billion in one financial year and enabled FPIs to spend on more debt instruments. With the recent rupee-settlement method, if an exporting nation is ready to accept rupee payouts, the pressure on India's forex reserves will be reduced.

Which nations are likely to adopt this new model?

While the RBI rule does not explicitly state it, this agreement is most likely limited to Russia. Following the Ukraine war, Russia was sanctioned, and the country was removed from the SWIFT system ( it is a system used by banks for paying in foreign currency). This means that payments will not have to be made in foreign currency, which will benefit both India and Russia.

There is no clear communication on how Russia has been compensated by India for imported products as of yet, and the system between both the nations must be seen in action.

Can this policy be applied to other nations?

It is highly improbable that it will be expanded to other nations. India currently accepts payments in INR from Nepal and Bhutan. India may want to use the rupee for international trade, but other nations may not agree because they require foreign currency to pay for their own imports.

How can the surplus balance in the Special Vostro Account be used?

This INR excess balance in the Special Vostro Account could be used to fund the following activities:

  • Development and investment payments
  • Advance flow management for exports and imports of goods
  • Investment in government securities,  treasury bills, and other subjects to FEMA and other statutory law

What is the procedure for establishing this new global trade payment mechanism?

All authorised dealer banks that use this mechanism must first obtain prior approval from the RBI's Foreign Exchange Department.  A partner country's bank has to reach out to an authorised dealer bank in India to open a Special Rupee Vostro Account.

That’s it about RBI’s new rule. Let us know what you think about its impact on the Indian economy? Will it appreciate the value of the INR for good?

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