RBI okays International trade transactions in rupees
The rupee has been steadily falling since early this year, and there are no signs of it picking up significantly soon. The question is, why is the Indian currency falling?
The value of the Indian rupee relative to the US dollar is determined by supply and demand. The value of the Indian rupee decreases as demand for US dollars increases and vice versa. Suppose a nation imports more than it exports. Hence, there will be a surplus of dollars, which will cause the rupee to lose value against the dollar.
The rupee has been losing value, particularly following supply chain delays brought on by the Russia-Ukraine war and other problems, including inflation, rising crude oil costs, and global economic difficulties.
As a result of Russia’s invasion of Ukraine, numerous nations cut connections with Russia and put sanctions on it. As a result of this, trade with the country has been all but nonexistent. In other words, the most significant oil exporter to the world market, Russia, was cordoned off.
Russia started selling oil at a discounted price to keep the ship from sinking, and the buyer was India. However, Russia could not access its dollar reserves, so rupees and rubles were used instead. This was a daring exception! Yet why? Because the US dollar serves as the default currency for all international financial transactions. And now, the Reserve Bank of India (RBI) has turned this exception into a law. That is a big deal!
The obvious question is: how would this new model work?
We must first examine the operation of the current system to understand this. Currently, if a business exports or imports, the transactions are always conducted in a foreign currency (excluding countries like Nepal and Bhutan). Therefore, the Indian company must pay in a foreign currency for imports (mainly dollars and could include currencies like pounds, Euro, Yen, etc.). When an Indian firm exports, it is paid in foreign currency, changing to rupees since it often requires rupees.
However, in the new framework, the Reserve Bank of India announced its decision to permit trade transactions between India and other nations in rupees. While the change is anticipated to positively impact trade with Russia in particular, it is also expected to have a limited positive impact on dollar outflow and rupee depreciation.
So now, let us see how a single transaction would go with the new framework?
Banks facilitate most international trade in the US. For instance, India would ask Russia for details on their already-established US bank account if India wished to import oil from Russia. Once the account has been located, India may fund it with dollars and purchase Russian oil. After that, Russia can use the money in the account to make further purchases.
But if to make the transaction completely dollar-free, you’d have to do a few things differently.
Consider a Russian oil exporter who will first ask one of their banks to set up a particular bank account in India called Vostro. Now. the importer of Russian oil will transfer the amount in Indian rupees into the Vostro account.
The Russian company now has rupees, but it requires rubles. Assuming a specific exchange rate, the banking partners will provide the exporters with the necessary amount in rubles. But what happens to the rupees in the Vostro account.
The Russian bank might accept rubles as payment if a Russian firm wishes to buy tea from India. The bank might also use the rupees in the Vostro account to pay the Indian tea firm. Additionally, the bank might buy Indian government bonds with any extra rupees sitting dormant in the Vostro account.
But there are apparent drawbacks to this approach. The scheme only succeeds if there is a great demand in Russia for Indian products and services. They can only employ the rupees effectively in this way. Therefore, we should hope that other nations can also find productive uses for the rupees rather than relying just on the US. Otherwise, you can’t do it.
The immediate benefits might not be undeniable. Analysts have welcomed the RBI’s move as progressive since it would make the Indian rupee more widely traded and less dependent on the US dollar. If everything goes as planned, perhaps more trading partners will actively use the rupee.