Rupee trade settlement provides structural benefits to India

Today, international trade is centered on what Gita Gopinath calls the “Dominant Currency Paradigm” (DCP), in which the US dollar holds dominance as the source, destination, and vehicle currency. The DCP affected national exchange rate policies by emphasizing the stability of the US retail price index and input costs. This, in turn, has produced a perpetual cycle in which the domestic peg of the dollar pushes more exporters, both domestic and international, to adopt dollar pricing, ultimately resulting in macroeconomic complementarity for the use of the dollar in foreign trade and monetary peg. . It is estimated that the dollar’s share of global bills is currently 4.7 times its share of global imports. This gives a clear picture of the strength of the US dollar and indicates that changes in the value of the US dollar affect world trade prices and volumes, making the value of the dollar considerably more important than bilateral exchange rates in predicting trade flows between countries.

In the case of India, 60% of all import-export payments are made in US dollars (and 86% in the case of imports). Even though an Indian exporter is paid in rupees, settlement at the sovereign level is done in dollars. The dominance of the dollar also means that the current decline in the rupee is more attributable to the strength of the dollar globally, even if the Russian-Ukrainian conflict and the subsequent trade sanctions imposed by the United States have produced a damaging trade framework for India. We depend on Russia for sunflower oil, wheat and energy. In April and May 2021, India’s imports from Russia were worth $2.5 billion, or about $30 billion a year, a figure that experts say could reach $36 billion a year. So if India paid for all of its Russian imports in rupees, it would end up saving $30-36 billion in outgoing dollars, in the best case scenario. Even a partial rupee settlement window can mitigate dollar outflows to a large extent.

Under these conditions, the July 11, 2022 decision of the Reserve Bank of India (RBI) to let domestic traders from abroad facilitate and settle billing and payments for international trade in rupees has been highly welcomed. .

This is essentially a waiver of the long-standing provision of the Foreign Exchange Management Act requiring final settlement in free foreign currencies. In practice, the rupee strategy would require foreign banks to open Vostro accounts in India, with settlements occurring instantly, allowing Indian exim dealers to settle rupee-denominated commercial invoices using these Vostro accounts. The policy also provides the parties with some leeway by allowing forward management of flows, achieved by utilizing excess rupee balances for authorized capital and current account transactions in accordance with mutual agreements. In the Russian context, this provision for opening bank accounts is limited to Russian banks that are not on the US Office of Foreign Assets Control (OFAC) sanctions list.

This political measure has a clear motive. The move comes as the rupee falls to historic lows against the dollar. Indeed, the sharp rise in world raw materials, in particular oil for imports, has driven our trade and current account deficits to worrying levels. According to some projections, the current account deficit could reach 3% of GDP in 2022-23 despite a record increase in exports. A weakening rupee heightens the threat of imported inflation in India, since we depend on imports for about four-fifths of our annual fuel demand. In this case, the policy would largely reduce the demand for foreign exchange for the settlement of trade flows linked to the current account.

It has economic and geopolitical implications. He liberalized capital account convertibility even as he sought to ease pressure on India’s dollar reserves. The flexibility of the capital account diminishes the function in trade of foreign exchange reserves. In addition, the move could help Indian exporters collect Indian rupee advances from overseas customers. Even though a Vostro account is not pre-funded, foreign importers will need to purchase rupees. Rupee payment method can be used to clear export and import transactions. Furthermore, this decision could have a long-term favorable influence on regional nations wishing to trade with India, if New Delhi encourages them to use the rupee as a base currency for trade diversification in their settlement procedures.

In terms of international politics, this decision is important because it signals the beginning of more concerted attempts to settle payments in currencies other than the dollar between Brazil, Russia, India, China and South Africa (Brics ), with other South Asian states seeming enthusiastic. too. In these turbulent times, as China and Russia forge alternative payment systems, this would support the position of the Indian Rupee in the international arena.

RBI’s move on rupee-denominated trade was aimed at reducing India’s trade deficit, as India can more easily increase its share of Russian oil purchases at discounted prices. However, a few questions still need to be clarified. Can exporters using the new rupee payment system apply for tax refunds under different schemes, such as Duty Drawback and Remission of Duties or Taxes on Export Commodities (RoDTEP)? We also need to monitor the impact of volatility in capital flows on our domestic economy in the context of India’s absorptive capacity. In conclusion, however, this de-dollarization push has potential as a risk management tool for the RBI and also the promise of long-term structural benefits in India’s international trade.

Amar Patnaik is a member of the Rajya Sabha of Odisha, a former CAG bureaucrat and a lawyer.

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