Eye on Emirati flows – There are both risks and benefits in the rupee-dirham settlement system

Source: The post is based on the articles

“Eye on Emirati flows – There are both risks and benefits in the rupee-dirham settlement system” published in The Hindu on 18^th July 2023 and

“Gently Pushing Rupee – Steady steps promoting rupee-based foreign trade are pragmatic. Internationalization follows economic heft” published in The Times of India on 18^th July 2023

Syllabus: GS 2 – Bilateral, Regional and Global Groupings and Agreements involving India and/or affecting India’s interests

Relevance: About the MoU between India and the UAE

News: Recently, the Reserve Bank of India (RBI) and the Central Bank of the UAE agreed to establish a framework for enabling the use of their local currencies for cross-border transactions.

What is the agreement about?

As per the MoU, all current account payments, including those involving the two countries’ exporters and importers, and certain “permitted” capital account transactions could be settled using either the rupee or the dirham.

The two central banks plan to create a Local Currency Settlement System and potentially link their payments messaging systems in the future.

This would lead to the development of a rupee-dirham foreign exchange market that would help in pricing the two currencies independent of their exchange rates with other currencies, such as the dollar and the euro.

This would also eliminate exchange rate risks for Indian and Emirati businesses when quoting prices for goods and services. It will enhance the ease of doing business and boost trade between the two countries.

The establishment of the India-UAE local currency settlement system has the potential to serve as a model for other bilateral currency agreements.

What is the purpose behind such an agreement?

To promote bilateral use of their local currencies and reduce reliance on the U.S. dollar as an intermediary for settling transactions and enhancing economic ties between the two nations.

It is also a step towards internationalizing the Indian rupee. This move aligns with India’s growing economy and its increasing share in global trade.

World Bank estimated that India was the first country set to receive an annual remittance flow of more than $100 billion. Linkage of India’s digital payments systems to other central banks will provide a further boost to remittance flows.

The RBI has indicated that increased investment by UAE-based firms is one possibility for utilizing rupee payments.

What are other measures taken by the RBI to promote rupee based international transactions?

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What are the challenges associated with the agreement between India and the UAE?

The success of the agreement will depend on the level of adoption by businesses in both countries. After the bilateral Comprehensive Economic Partnership Agreement, the UAE’s trade surplus with India has increased.

As a result, Emirati businesses must identify profitable ways to use potential rupee flows if they choose to accept payments in the Indian currency.

What can be the way ahead?

Despite such possibilities, in a rapidly evolving global environment, businesses will base their decisions on economic logic. Policymakers must also remain aware of the risks arising from such moves even as they eye the opportunities.

Moreover, RBI’s gradual approach is pragmatic as it allows retail transactions at a lower transaction cost and encourages rupee settlement for cross-border trades.

However, enhanced internationalization requires GOI to revisit its restrictive foreign trade and capital account policies.