In a year which saw a storm in all currency markets, Russia’s rouble has come full circle.

On March 10, the rouble hit a low of 150 against the US dollar from a stable level near 70 for the past two years.

But on June 26, doing a volte face, rouble reached almost 50 against the US dollar, its strongest level in seven years. What is happening with the rouble and how does it impact India?

The West imposed draconian sanctions on Russia in response to the Ukraine invasion. The immediate impact was the collapse of rouble. Russia took many measures to arrest the fall. The Russian central bank mandated that 80 per cent of foreign earnings of Russian firms had to be converted to rouble. It increased interest rates to 20 per cent from 9.5 per cent in one go.

Russia decreed that hostile country buyers had to pay in rouble for buying natural gas. This resulted in increased demand for roubles and its appreciation. This was aided by a historical rise in the prices of oil and gas and continued demand for Russian energy products. An appreciating rouble gave Russians a sense of pride which overshadowed the mounting losses in Ukraine.

But the s,tory here is also somewhat deeper. There has been a complete collapse of imports as they fell to multi-decade lows due to the sanctions. Russia was also removed from the global payment system SWIFT. Hence, there is no need or possibility for them to sell roubles to buy foreign exchange. So ruble is currently like an illiquid unlisted firm with no way to determine its fair price. If a currency is not traded in the market and the demand for the foreign currency evaporates, what is its true equilibrium price?

Impact on India

India and Russia have been long standing strategic partners with bilateral trade at around $13 billion in March 2022.

In the short term, the immediate benefit to India is to buy cheaper crude oil from Russia. In the medium term, Western countries vacating the Russian business space can provide uncontested market access to Indian products. In the long run, diversification of energy sources away from West Asia is a critical aspect of energy security and consequently national security.

With the current restrictions expected to continue, it would be extremely difficult to use reserve currencies for trade with Russia. As per reports, the solutions being discussed are a ‘rupee-rouble’ mechanism and a new BRICS currency based on a basket of member currencies.

In international trade, profitability is dependent on the price of products and exchange rate between the currencies. Since the value of rouble is indeterminable, it cannot be blindly used in settling trade. Else all gains may turn out to be merely paper profits.

Since convertible currencies like USD are unusable, the best solution for India is to insist on a rupee payment mechanism. The imports by India and Russia would be both settled in INR. This would be a concrete step towards internationalisation of the rupee.

Indian firm UltraTech recently used Chinese yuan to buy Russian coal. This strengthens the internationalisation process of Yuan and given our competitive interests in the region, is not the best way out.

Internationalisation of rupee will be beneficial for India as it lowers transaction costs of trade and investment operations by mitigating exchange rate risk. By decreasing demand for foreign exchange, it supports the value of rupee. It will help our companies with lower hedging and borrowing costs and provides our financial companies scope for global expansion. It will also give India political leverage and increased soft power. These will go a long way in establishing a leadership position for India in the world in general and in the Asia Pacific region in particular.

Russia may have reservations on this due to the limited use of the excess rupee balances arising out of the bilateral trade deficit. But in the long term with Indian companies displacing West in exports to Russia, the trade deficit is expected to narrow. The process has already started. Confederation of All India Traders (CAIT) said that trade organisations from Russia are seeking assistance to connect with Indian manufacturers, traders and exporters.

The RBI noted in its report that internationalisation of rupee is inevitable, but it did point out some risks involved. This makes the simultaneous pursuit of exchange rate stability and a domestically oriented monetary policy more challenging. It can potentially limit the ability of the central bank to control domestic money supply and influence interest rates. However no worthy goal comes without some risks and we should embrace the challenges to claim our rightful place in the world. The RBI by recently allowing the trade to be denominated and invoiced in the Indian rupee has taken the first step.

India can use this opportunity to strengthen its ties with Russia. Holistically, this situation can provide a unique opportunity to strengthen our economic, energy and national security.

Mittal is an IAS officer and Singh is an ex-Indian Trade Service officer. Views expressed are personal