The July 11, 2022, notification from RBI titled ‘International Trade Settlement in Indian Rupees (INR)’ has been hailed as an innovative move to counter the recent sharp depreciation of the rupee and to establish the rupee as a multilateral currency. The notification will allow exports and imports from many countries, including Russia to be denominated in rupee (INR). The foreign entity (exporter or importer) will have to open a Vostro account with an Indian bank that would act as a correspondent bank with the designated domestic bank of the foreign entity. The surplus balance in the Vostro account can be used for capital and current account transactions permissible under FEMA and other applicable regulatory provisions. The article examines the impact of the measure in the short term and in the longer term.
Immediate Implications
The key implication for an Indian company is that it will not be required to transact in foreign currency if the transaction is denominated in INR. Without this facility imports and exports would have resulted in buying and selling of foreign currency by the Indian company. The foreign business partner of the Indian company will now be the only party to transact in the foreign exchange market. Ceteris paribus, however, there would be no change in the demand and supply of foreign currency in the Indian market. As the cost and the risk associated with conversion from one currency into another would be borne entirely by the foreign partner, there would be consequences for the Indian company – it will pay more for imports and receive less from exports. Therefore, denominating foreign trade in INR makes no difference to the foreign exchange market, unless repatriation of funds from the Vostro accounts is restricted. However, if such a restriction is imposed then the very motivation for the proposed policy – that of encouraging the denomination of international trade in INR – would be defeated.
The policy facilitates the holding of foreign currency reserves in INR. In the extant situation, due to sanctions imposed by the Western countries, the Russian entities exporting oil and gas have agreed to hold INR reserves by denominating the trade in INR. The INR earned by them may be used for buying goods and services from the Indian market or investing in Indian assets. The balance in their Vostro accounts measures the reduction in the demand for dollars (from importers) that would have otherwise ensued. The arrangement, therefore, slows the depreciation of the rupee against the USD. The persistently high inflation rate in India and the recent accelerated depreciation of the rupee, however, have unnerved the Russian exporters. Their disquiet with the ballooning of the amount held in INR resulted in their (recent) demand that the payments should henceforth be made in dirham, the currency of UAE. The UAE has maintained a neutral stance on the Russia-Ukraine war and has not imposed any sanctions on Russian entities. The new stipulation by the Russian exporters completely nullifies even the ephemeral benefits of paying in INR. The benefit that would remain would be the discount Russian exporters are offering on their oil and gas prices vis-à-vis the international prices.
In sum, therefore the proposed policy has limited immediate benefits. The use of INR reserves for any additional purchase of goods and services from India, not contemplated earlier, would help boost exports from India and enhance the aggregate demand in the economy.
Longer-term Implications
It would be useful to delve into the history of Indian currency to develop a longer perspective.
While the silver standard for the Indian currency can be traced to the slave dynasty in the thirteenth century, it was Sher Shah Suri who issued the first rupiya during his brief reign from 1537-45. A gifted general as well as an able administrator, the issue of rupiya was a part of his new economic administration. The reforms Suri introduced lasted well beyond the end of the Suri dynasty with the defeat of his son by the Mughal Emperor Humayun in 1555. The rise of rupiya as a pan-India currency and a currency for international trade was firmly established during the reign of Mughal Emperor Akbar (1556-1605). The silver bullion brought by the European East India Companies was minted into Indian rupiya that was used by the companies for supporting their trade. In 1677, when the English East India Company started minting silver rupees in India, it maintained parity with the Mughal rupiya. With the spread of the British empire, the circulation of the Indian rupee scaled up significantly as it became the de facto currency across the British colonies.
The Indian rupee continued to be used as currency by many countries that had a significant presence of Indian diaspora even after India’s independence in 1947. The massive devaluation of the rupee by over 57% by the RBI on June 6, 1966, to deal with a severe balance of payment crisis, dealt a fatal blow to the international confidence in the rupee. On September 18, 1966, Dubai (later to become a part of UAE) shifted to the dirham from the rupee. By 1973, Oman became the last country to shift entirely out of the rupee to Omani rial. That ended the 400-year-long history of the rupee as a multilateral currency.
The acceptance of a currency as a store of value and for international transactions by many countries is dictated by the political and economic strength and stability of the issuing country. Another requirement for a currency to become a global currency is full convertibility. India does not qualify on these parameters. The RBI policy therefore should be seen as an opportunistic response to the concerns that have arisen from the severe sanctions on Russia, Russian entities, and individuals, by the Western countries. It has practically no implications for the rupee regaining its lost glory as a multilateral currency.