Rupee trade settlement offers India structural benefits

Source: The post is based on an article “Rupee trade settlement offers India structural benefits” published in Live Mint on 30^th September 2022.

Syllabus: GS 3

Relevance: measures taken by the RBI to tackle falling rupee

News: RBI has taken a decision recently to let domestic exim traders facilitate and settle invoicing and payments for international trade in rupees.

This is a welcome step as it will reduce India’s trade deficit and India can more easily raise its proportion of Russian oil purchases at discount prices.

How is this measure helpful?

It is a departure from the long-standing Foreign Exchange Management Act provision mandating final settlement in free foreign exchange.

It would need foreign banks opening Vostro accounts in India with settlements taking place instantly. It would further allow Indian exim dealers to settle rupee-denominated trade invoices using these Vostro accounts.

It also provides the parties with some leeway by allowing advance flow management.

It is done by using excess rupee balances for permissible capital and current account transactions in accordance with mutual agreements.

The provision for opening bank accounts in the case of Russia is limited to Russian banks that are not on the US-Office of Foreign Assets Control (OFAC) sanctions list.

Therefore, this step has come as the rupee falls to historic lows versus the dollar.

Why are the consequences of falling rupee?

Imports: The sharp rise in global commodities, particularly oil imports have caused India’s trade and current account deficits (CAD) to worrying levels.

The current account deficit is expected to touch 3% of GDP in 2022-23 despite a record increase in exports.

Inflation: A weakening rupee worsens the threat of imported inflation in India, since India is dependent on imports for about four-fifths of its annual motor-fuel demand.

Therefore, this policy would lower demand for foreign exchange for the settlement of current account-related trade flows.

Further this step taken by the RBI also has economic and geopolitical implications.

How this measure has economic and geopolitical implications?

First, it has liberalized capital account convertibility to decrease pressure on India’s dollar reserves. Capital account flexibility diminishes the function in trade of currency reserves.

Second, the move could assist Indian exporters in collecting advance payments in Indian rupees from overseas clients.

Third, even if a Vostro account is not pre-funded, foreign importers will have to buy rupees. The rupee payment method can be used to set off export and import transactions.

Fourth, the move could have a favourable long-term influence on regional nations wanting to trade with India.

Moreover, the measure will also affect international politics.

How will this measure affect international politics?

First, it signals the beginning of more concerted attempts to settle payments in non-dollar currencies among BRICS nation and with other South Asian countries.

Second, it would support the Indian rupee’s position on the internationally with China and Russia looking for alternative payment systems.

Moreover, the US dollar holds importance around the globe including in India.

How does US dollar hold importance around the globe and in India?

Internationally: The US dollar is defined as Dominant Currency Paradigm’ (DCP) which means the US dollar holds importance as the source, destination and vehicle currency.

The DCP has affected national exchange-rate policies by emphasizing the stability of the US retail price index and input costs.

According to estimates, the dollar’s proportion of global invoices is currently 4.7 times more than its share of global imports.

India: 60% of all export-import payments in India are made in US dollars (and 86% in the case of imports).

The settlement at the sovereign level is carried out in dollars even if an Indian exporter is paid in rupees.

Moreover, the rupee’s current depreciation can be given to dollar strength globally.