Foreign trade in the current economic landscape is centered around US dollars. Financial experts refer to it as the ‘Dominant Currency Paradigm’ or DCP as it is undoubtedly the ‘go to’ monetary source, destination, and vehicle currency for most countries to carry out foreign trade.
This has been the case historically.
What’s the Backstory of the Trade Through Rupee Accounts?
The role and dominance of the dollar in foreign trade have been brought into question as the Biden administration, for the first time, attributed ‘inflation’ as a critical global threat with the likes of Russia and China. However, the US Strategy paper said that this inflation was no longer a domestic issue and highlighted the struggle of people all over the world.
You can lay partial blame on the Russia – Ukraine war and the pandemic that were the key reasons behind bolstering price rise and inflation across the globe.
The Federal Reserve, the US central bank, has periodically increased interest rates to curb price rise and inflation on the domestic front. However, it has not helped drive a reverse price rise trend in the long term. The significant consequence of this has been felt across developing nations despite many of them not carrying out foreign trade with the US directly.
What Does It All Mean for India and its People?
Inflation in the US spreading across the globe has led to a weakening rupee against the dollar as the US bank rates keep rising intermittently. This has created concern at the national level despite other vital factors, such as a positive increase in GDP driving growth in the Indian economy.
The typical Indian is the one who is most impacted by the weakening rupee and increase in dollar rates as India continues to transact the bulk of its foreign trade in US dollars. It will help to put things into perspective.
When it comes to India’s foreign trade, 60% of financial transactions are done in US dollars, 86% of which are for imports alone. Even if the exporter settles in rupees, the sovereign-level transaction happens in US dollars.
- Every year India imports significant quantities of gram and dals which ultimately is food for Indians both rich and poor.
- Palm oil is also a key commodity that India imports, which many Indian households use.
- Also, consider the Indian students who are currently enrolled in US universities where parents are having to fund their education by shelling out more because the rupee is weak against the dollar
In a nutshell, the rise of the US dollar has been detrimental to India’s foreign trade.
Has India Found a Way Forward?
The rupee fell to a record low against the US dollar combined with a sharp price rise in global commodities such as oil. It has driven trade and current account deficits to worrying levels.
As the bulk of the foreign trade transactions takes place in US dollars it was important for the central government in collaboration with the Reserve Bank of India to come up with a way forward that will turn around the Indian economy for the better.
In alignment with this thought, the RBI issued a circular on the 11th of July 2022 that established a framework allowing Indian companies involved in foreign trade to invoice, pay, and settle their export and import orders in Indian currency in addition to the regular payment modes.
Promoting trade through a rupee account would help the interest of Indian exporters and support a global trading community wanting to do business in INR. The integration of the rupee AC will enable Indian companies to settle their accounts with other countries in INR. In theory, this move could possibly become an alternative to SWIFT.
The idea became more concrete when India wanted to trade with Russia as the US imposed sanctions and denied Russia access to the SWIFT system. Other than simplifying foreign trade with Russia, the system is designed to check the US dollar outflow from the country. This, in turn, would automatically help to slow down the pace of the rupee depreciation against the US dollar to some extent.
How does the Rupee AC Trade System Work?
The proposed Rupee AC trade framework by the RBI enables the settlement of foreign trade transactions with any partner country. To initiate the transactional relationship, Vostro accounts correspondent bank/s of the partner country would have to be opened in banks in India to kick off the trade. Indian importers will then be allowed to make payments for their imports into the country in Indian Rupee directly in these Vostro accounts.
What are the Long-Term Benefits for India?
RBI’s priority in encouraging a shift toward trading via rupee accounts was to minimize foreign trade deficits. This would allow India to raise its proportion of oil purchases from Russia at affordable prices. Moreover, this will establish a more transparent and efficient system of foreign trade and pave the way for the INR to be accepted as a global currency for foreign trade.
India already has new free trade agreements (FTA) with countries like Australia and the United Arab Emirates and is in the negotiating stage to sign more with the likes of the European Union, the UK, and Canada. India can potentially increase their level of economic engagement with FTA partner countries with a pre-existing international settlement mechanism in the Indian Rupee in place.
India’s proposal of a Rupee AC has already sparked interest in the international community with four to five countries expressing interest in settling foreign trade transactions in Indian rupees. Moreover, a push towards de-dollarizing can promise several long-term structural benefits in India’s international trade going forward.
1. Why does RBI want to settle foreign trade payments in INR?
Settling foreign trade payments in INR with help RBI minimize India’s dependency on US dollars to carry out international trade.
2. Is the Indian rupee free floating?
According to RBI Governor Shaktikanta Das, the Indian rupee is a free-floating currency with its exchange rate determined by prevailing market conditions.
3. Can Indian Rupee be used in foreign trade?
After RBI’s 11th July announcement, Indian Rupee can be used in international trade