Explained: International trade settlement in Rupees and why RBI is doing it

• RBI is trying to make the Rupee globally acceptable for trade by letting settlements happen in Indian currency, instead of US Dollar.
• RBI’s efforts will bear fruits, if any, only in the long term and experts don’t see anything changing in the near future.
• What exactly does it mean when RBI says international trade can be settled in Rupees? We break it down here.

The Reserve Bank of India’s efforts to keep the Rupee stable and cut down the use of the US Dollar – a decades-old habit that most of the world seems unable to shake off – has seen an earnest beginning with the central bank now allowing invoicing of international trade in Rupees.

“This is to facilitate greater trade in Rupee. Previously Rupee invoicing was allowed but it was not so popular as surplus Rupee were not allowed to be channeled back into Rupee assets. Now they are. For a currency to be globally acceptable, capital flows and trade have to be liberalized hand in hand,” Anindya Banerjee, VP, currency & interest rate derivatives at Kotak Securities told Business Insider India.

But what exactly does this mean? We try to explain this in simple terms.

What is international trade settlement in rupees?

When countries import and export goods and services, they have to make payments in a foreign currency. Since the US Dollar is the world’s reserve currency, most of these transactions are entered into US dollars.

For example, if an Indian buyer enters into a transaction with a seller from Germany, the Indian buyer has to first convert his rupees into US dollars. The seller will receive those dollars which will then be converted into Euros.

Here, both the parties involved have to incur the conversion expenses and bear the risk of foreign exchange rate fluctuations.

This is where trade settlement in rupees comes in – instead of paying and receiving US dollars, the invoice will be made in Indian rupees if the counterparty has a Rupee Vostro account.

The decision to allow international trade in rupees is aimed at easing trade with Sri Lanka, which is running low on forex reserves, and Russia, which cannot make payments in US dollars due to sanctions by the West.

What is a Vostro and Nostro account?

To accept payments in rupees, authorized dealer banks will be able to open special Rupee Vostro accounts.

A Rupee Vostro account is a foreign bank’s account with an Indian bank in rupees in India.

For example, HSBC holding an account with the State Bank of India in the Mumbai branch, denominated in rupees, is called a Rupee Vostro account.

Foreign parties will be able to send and receive money from Indian exporters and importers via these Rupee Vostro accounts.

On the other hand, a Nostro account refers to an Indian bank’s account with a foreign bank in foreign currency in the foreign country. It’s like SBI holding an account with HSBC in London, denominated in British pounds.

Why does the RBI want to settle payments in Rupees?

This move will help reduce India’s dependency on US dollars. Experts Business Insider India spoke to suggested that while this decision won’t have a considerable short-term impact, it will benefit the country in the long-term.

“We see little impact on USDINR value over the short to medium term. Over the long term it will shift some demand into Rupees from USD. But the impact of that USDINR will be very gradual,” Anindya Banerjee, VP, currency & interest rate derivatives at Kotak Securities told Business Insider India.

Sanctions on Russia due to its war on Ukraine, and the West subsequently cutting off Russia from the SWIFT payments system is likely one of the motivating factors behind this decision.

“The recent Ukraine-Russia crisis and sanctions on Russia was a real eye opener for most countries who are now trying to lower their dependency on the US dollar,” Heena Naik, research analyst - currency, Angel One told Business Insider India.

Moreover, since India runs a trade deficit – its imports are greater than exports – settling trades in rupees will also save dollar outflows. At a time when the rupee’s value is declining every week against the US dollar, saving dollar outflows becomes even more critical for the RBI.

Circumventing the SWIFT payments system and paying for imports in rupees would also help India work around the sanctions imposed on its trade partners – Russia being the latest, and Iran is another prominent example from the past.

How much will India save with this decision?

According to the latest trade data, India’s imports from Russia stood at $2.5 billion in April and May. This annualizes to $30 billion, and experts suggest it could increase to as much as $36 billion annually.

In the best-case scenario, if India pays for all of its Russian imports in rupees, it would end up saving $30-36 billion in dollar outflows.

For context, the RBI recently spent $40 billion in keeping the Rupee stable, and it could spend another $40 billion.

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