Article:
India and Malaysia recently agreed to settle their bilateral trade in Indian rupees, a move expected to boost the countries’ USD 19.4 billion trading relationship. This move is significant in that it reflects India’s efforts to de-dollarize its international trade. This article discusses the implications, benefits, and challenges of this decision.
Trade Settlement in Rupees: An Overview
In July 2022, the Reserve Bank of India (RBI) granted permission for the settlement of international trade in Indian rupees. The first foreign trade settlement in rupees occurred in December 2022 with Russia, a result of the ‘International Settlement of Trade in Indian Rupee’ mechanism launched by the RBI. By March 2023, the RBI allowed banks from 18 countries, including Malaysia, the UK, and Germany, among others, to open Special Rupee Vostro Accounts (SRVAs) to settle payments in Indian rupees.
Significance and Benefits
One major advantage of settling trade in rupees is its potential to control the depreciation of the currency. As a net importer, India often experiences an outflow of dollars, causing the value of the rupee to decline. By employing the rupee in international trade transactions, this outflow can be curtailed, preserving the value of the currency to a limited extent and reducing pressure on the country’s forex reserves.
Another benefit is better pricing for goods and services. The ability to invoice trade in rupees allows Indian traders to achieve more favorable pricing. Additionally, the mechanism is expected to reduce currency conversion spreads, thus benefiting both sides of the trade.
The use of rupee for trade settlements could also pave the way for global acceptance of the currency, contributing towards its internationalization and creating possibilities to repay loans from fund banks like the Asian Infrastructure Investment Bank.
Challenges and Implications
One significant challenge is the volatility of the Indian rupee, which can be subject to considerable fluctuations in the foreign exchange market and may deter international traders from using it as a settlement currency.
Additionally, the RBI warned that the internationalization of the rupee might limit the central bank’s ability to control domestic money supply and influence interest rates, potentially complicating monetary policy formulation.
The rupee might also face competition from major currencies such as the US dollar, Euro, and Yen, which are widely accepted for international trade settlements.
Understanding Special Rupee Vostro Accounts
A Vostro account is an account held by domestic banks for foreign banks in the domestic currency – in this case, the rupee. It is used to provide international banking services to clients with global needs. The bank holding the Vostro account acts as custodian of the foreign bank’s funds and offers services like currency conversion, payment processing, and account reconciliation.
In summary, India’s recent move to settle trade in Indian rupees with Malaysia represents an important step towards the internationalization of the rupee. However, to effectively manage this transition, India needs to boost its exports and undertake critical reforms, including capital account convertibility and deepening financial markets to manage large-scale capital inflows and outflows.
