The hegemony of the major hard currencies — the dollar, pound, euro and yen — as trade invoicing currencies is well-known. In particular, irrespective of the origin and destination, exports and imports of countries tend to get denominated in these currencies, led by the US dollar. There is, thus, a significant asymmetry in international trade, where countries often invoice their trade in a vehicle currency that is neither the currency of the exporter nor the importer.
In this context, the July 11, 2022, notification of the Reserve Bank of India attracted widespread attention. The notification, titled ‘International Trade Settlement in Indian Rupees (INR)’, allowed cross-border trade in Indian currency under the Foreign Exchange Management Act (FEMA) 1999.
Under this arrangement, the RBI lays out the rules which allow Indian exports and imports to be denominated and invoiced in INR, using market-determined bilateral exchange rates. What has been the trigger of such a measure? Has it been prompted by the current chaos in payment created by the sanctions against Russia? Or are there strategic considerations?
An arrangement of rupee-denominated trade is not new for India. From the 1970s till about the early 1990s, India had similar bilateral agreements with the erstwhile USSR and some Eastern European countries; the only significant difference being that such trade used to happen using bilaterally agreed fixed exchange rates.
Since 1991, as India adopted a regime of flexible exchange rates and attained the status of current account convertibility by 1994, it gradually moved away from such rupee-denominated international trade.
What is the currency basket of India’s trade? Presently, India’s international trade is mainly denominated in the dollar and the euro. A database published by the International Monetary Fund in 2020 shows that while in 1992, 20.4 per cent of India’s exports were invoiced in INR, by 2000 the number was only 0.3 per cent ( www.imf.org/-/media/Files/ Publications/ WP/2020/Datasets/wp20126. ashx).
In 2014, the latest year for which such data are available for India, the shares of the dollar and the euro in the Indian export basket were 86.8 per cent and 7.7 per cent, respectively. Exports invoiced in all other foreign currencies were only 5.5 per cent. According to this database, since 2005, India did not report any rupee-denominated exports. It is notable that while in 2014, 86.8 per cent of India’s exports were dollar-denominated, the US accounted for only around 13 per cent of India’s exports during the same period.
This disproportionate use of the dollar stems from the unique position of the USD in international trade and commerce. It is likely that the use of a vehicle currency is often preferred as a medium of exchange because it reduces transaction and coordination costs for the exporters and the importers. Stability of the vehicle currency in terms of inflation, volatility and liquidity are important factors which propagate uses of the vehicle currency as a more stable unit of account.
Finally, as vehicle currencies are likely to have deeper markets and are more widely accepted, economic agents involved in international trade may prefer such currencies as a better store of value. Consequently, the dollar has an overwhelming dominance in international trade and commerce.
According to estimates, the dollar’s share as an invoicing currency is around 3.1 times its share in world exports. Given this dominance of the dollar in international trade, have recent geopolitical developments driven the RBI towards introducing rupee-denominated trade? The Russia- Ukraine conflict has led to widespread sanctions on Russia’s central bank and its international trade transactions. Several Russian banks are also barred from the Swift financial messaging system. On the other hand, India, a big oil importing country, is suffering from the triple whammy of rising oil prices, massive outflow of foreign capital and an appreciating USD.
In this context, the rupee-denominated trade can be a win-win for both India and Russia, as India will be able to import cheaper Russian oil, possibly bypassing some of the restrictions of the Western financial mechanisms. This will allow Russia to import some essential goods, like pharmaceuticals, from India.
Indian and Russian exporters will benefit from better market access in the partner country. Similar mutual benefits can also be explored with a few other countries like Iran, which possibly do not prefer to use vehicle currencies like the USD in international trade.
It is to be noted that rupee-invoiced trade between India and a partner country does not have to be balanced. In case the trade is not balanced, the RBI has allowed the surplus funds to be invested in the Indian capital market. Such investments can be repatriated, subject to capital account regulations.
Admittedly, the rupee-invoice trade arrangement by the RBI is not Russia or oil specific. As several countries in South Asia are facing financial problems and foreign exchange constraints, a framework of rupee-denominated international trade can be useful for these countries as well. Illustratively, India has promised a few billion dollars of credit line to Sri Lanka.
From a more medium- to longer-term perspective, this may allow India to take a small stride away from using a vehicle currency in regional trade. With the right kind of logistics and diplomatic support, this may pave the path to creating a rupee-dominated currency bloc in South Asia. While at this stage, the internationalisation of the rupee is well beyond the immediate horizon, regionalisation of the rupee can be a step in that direction.
However, there are complications. There can be discomfort among the US policymakers about countries moving away from dollar-invoiced trade and thereby sidestepping its sanctions against Russia and some other countries. There are reports that Russia is increasingly demanding trade to be denominated in dirhams. The end-game will, thus, be political and diplomatic. While India will have to tread cautiously, these measures could address both immediate concerns and strategic considerations.
Pal is Professor of Economics at IIM Calcutta, and Ray is Director of the National Institute of Bank Management, Pune. Views are personal