Decoded: How the rupee trade settlement is tied to India’s trade deficit and forex reserves
- As a net-importing country, India’s forex reserves have come under pressure due to the surge in the value of the US dollar.
- To help ease some of this pressure, the Reserve Bank of India announced a policy to allow international trade settlement in rupees.
- But will countries really be interested in using the Indian Rupee and not the US Dollar? We try to understand the motivations and challenges involved in doing so.
AdvertisementIndia is a trade deficit country, meaning it imports more than it exports. This forces the country to maintain large forex reserves, since world trade still occurs in US dollars. The ongoing pressure on the Rupee and its decline against the dollar pushed the Indian central bank to put in place a mechanism earlier this week to allow international trade in rupees.
To be clear, this is not the first time that the Reserve Bank of India (RBI) has allowed international trade in rupees – the sanctions on Iran a few years ago resulted in the two countries trading in rupees instead of dollars. Now, the Russia-Ukraine war and the subsequent sanctions have provided RBI with another opportunity to push for trading in rupees.
Since India is a net importer – with its imports exceeding exports by over $87 billion (about ₹6.87 lakh crore) in 2021-22 – and the value of Indian rupee has been declining consistently, RBI’s latest decision to allow international trade in rupees is expected to reduce the pressure on India’s forex reserves.
Why would other countries want to trade with India in rupees and not dollars?
RBI’s move would reduce the outflow of US dollars and shore up demand for the rupee. This would allow the central bank leeway to conserve its forex reserves and deploy it to keep the rupee stable.
But why would any country switch to using the Indian rupee for its trades with India, especially when the US dollar acts as a common point for all countries, thanks to its status as the world’s reserve currency?
At a very simplistic level, this is like two Indians deciding to use an alternative mode of exchange that they have come up with, instead of using rupees. In other terms, this is similar to the barter system.
The main reason for countries to want to trade with India in rupees is this: the US dollar has been going through a phase of strength against most currencies in the world. Here is a snapshot of how some currencies have performed against the US dollar in the past one year:
|Sri Lankan Rupee||-83.2%|
The US dollar’s strong performance has essentially made imports expensive for most countries. Sri Lanka, which is going through one of its worst economic crises in decades, is a glaring example of a country in which the economy has come to a halt due to a drastic fall in forex reserves.
While the Sri Lankan Rupee has declined over 83 percent against the US Dollar, its fall against the Indian Rupee has been lower at 70 percent.
So instead of paying 83 percent more to make purchases in USD, Sri Lanka can pay in Indian Rupees and save some money.
Will countries with trade surplus with India want to trade in rupees?
The question that RBI and the Indian government will have to answer is this – why would countries with a trade surplus with India want to trade in rupees?
For instance, China had a $73-billion trade surplus with India in 2021-22 – that is, Indian imports from China exceeded its exports to China by $73 billion.
If China were to trade with India in rupees, it would have Indian rupees worth $73 billion (about ₹5.77 lakh crore) sitting idle in its Rupee Vostro accounts in an Indian bank.
China would either have to invest this money in India, or let it lie idle in its accounts. But that is not an interesting proposition when China can simply trade with India in US dollars and not have to deal with this headache.
Essentially, countries whose exports to India are more than imports, will not be too enthusiastic to trade in rupees, especially if the difference is huge as in the case of China.
For now, though, it looks like trade settlements in rupee will be limited to countries like Russia and Iran, which are facing sanctions from the West, and Sri Lanka, which is going through an economic turmoil, and a few other immediate neighbours of India.
Advertisement"While RBI’s decision regarding the rupee settlement system for international trade will see the immediate release of price pressure and possibly increased oil purchases with Russia and trade with sanctioned countries like Iran, the increasing interest in bilateral trade and investment activities will mean willing trading economies and Indian exporters finding a fungible instrument that eases the eventual transaction pressure,” said Adarsh Sharma, Managing Director and the head of the Investment Realisation practice at Primus Partners.
Explained: International trade settlement in Rupees and why RBI is doing it
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