Diversifying from dollar

The Reserve Bank of India’s permission to Indian importers and exporters to settle their transactions in the rupee is a significant step towards reducing India’s dollar dependence and diversifying its foreign currency reserves. While this will immediately make processing of trade transactions with Russia easier, the benefits which are likely to accrue over the long term are more significant. The settlement mechanism has been designed in such a way that it needs the involvement of only the trading partner country and its banks. It enables invoicing of all exports and imports in rupee and settlement at a market determined exchange rate. Indian banks have been allowed to open special rupee vostro accounts of banks of the partner trading country. All payments made by Indian importers and receivables of Indian exporters will be channelled through these vostro accounts. This process has already been tested while paying for crude oil imports from Iran in rupee. The sweeping permission given by the central bank this week to allow settlement of all international trading transactions in the Indian currency provides an enabling mechanism to enter into bilateral agreements with all willing trading partner countries to implement a different method of trade settlement.

If the number of countries with whom such deals are signed expands, it could ease the burden on India’s exchange rate and external account. India’s trade deficit has expanded considerably in the last two decades. While structural changes in the composition of the country’s import and export basket are the best way to address this imbalance, settling external trade in the rupee reduces India’s vulnerability to bouts of dollar strength and the exchange rate volatility caused by domestic demand for the dollar perpetually outpacing supply. This is also a definitive step towards internationalising the rupee and an attempt to hedge against the overarching dominance of the US dollar. Given the debasement of the dollar in recent years due to excessive note-printing by the US Federal Reserve, most emerging economies would prefer to hold less of dollar denominated securities in their foreign exchange reserves. But heavy reliance on dollar trade makes such diversification difficult. The payment mechanism suggested by the RBI may, however, have to be tweaked based on preferences of other major trading partners, as some countries may prefer trade settlement in their domestic currency. These hurdles can however be surmounted once there is the will to increase use of the rupee.

The RBI has also been prudent to encourage exchange of messages regarding these bilateral trade transactions in a ‘safe, secure, and efficient way’ as agreed between the banks of partner countries. It may be recalled that global trade had been greatly disrupted when Russian banks were barred from using the SWIFT messaging system early this year. Creation of bilateral messaging platforms could well be the way ahead to avoid difficulties arising out of future geopolitical tensions. The RBI has also stated that surplus money held in these vostro accounts (of foreign banks in India) can be used for permissible capital and current account transactions. With India’s imports being higher than exports, there will be surpluses in these accounts. These funds can be channelled into infra projects, government securities and treasury bills, as directed by the RBI, thus helping the economy.

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