*****Trading gains | Business Standard Editorials

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Rupee settlement will increase flexibility

The Reserve Bank of India (RBI) has done well to allow international trade settlement in Indian rupees. This will give importers and exporters another option to settle payments. The central bank on Monday announced all imports and exports under the new framework could be denominated in rupees. The exchange rate with the trading partner will be market-determined. Accordingly, for settling trade, Indian banks have been allowed to open special Vostro accounts in banks of the trading-partner countries. Thus, Indian importers will be able to make the payment in rupees, which would be credited to the special account in the trading-partner country. Similarly, exporters can receive payment from overseas in rupees. The new system, which according to the RBI has been introduced to promote international trade and exports from India, has come at an interesting time.

The rupee, along with several other currencies, is under pressure and the RBI is using its reserves to slow the depreciation. Fundamentally, the current account deficit (CAD) is likely to be higher than 3 per cent of gross domestic product this fiscal year, and the capital account is also witnessing outflows because of rising risk aversion in the global financial system. Foreign portfolio investors have sold Indian assets worth over $30 billion since the beginning of the year. Theoretically, if a significant part of India’s trade is settled in rupees, financing the CAD would become easier, providing greater stability to the exchange rate. Since India runs a CAD, it is likely that trading partners would be left with surplus rupees, which can be used to invest in Indian assets.

However, this is unlikely to happen in the short run. Most of the global trade is settled in US dollars and is likely to remain so in the foreseeable future. As a 2021 research note by economists at the US Federal Reserve showed, the dollar share in global trade invoicing between 1999 and 2019 was 97 per cent in the Americas and 74 per cent in the Asia-Pacific, while in the rest of the world it was about 80 per cent. Invoicing is done in dollars predominantly because it is seen as the most stable currency. When Indian importers and exporters deal in dollars, they bear the exchange rate risk — a change in the value of the rupee against the dollar. Settling in rupees will shift this risk to the trading partner. However, not too many trading partners would be willing, particularly in the current circumstances.

In the given situation, though, this arrangement could prove to be useful in dealing with Russia and Sri Lanka. India’s increasing energy imports from Russia can be settled in rupees. This would also help bypass the Western financial system, which has cut off Russia. In the case of Sri Lanka, the government of India can extend support in rupees, which can be used to import essential items such as food and medicine from IndiaSri Lanka is facing a serious economic crisis, resulting in a shortage of most essential items. India has been extending support to the extent possible. It would be easier for India to increase the scale and scope of support if it can use its own currency. Thus, at a broader level, though trade settlement in rupees may remain limited, it will increase flexibility and could be useful in certain circumstances.

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