The Reserve Bank of India on Monday gave the go-ahead for a rupee-denominated settlement mechanism for international trade. It is for international trade, and the mechanism will help any such trade to be settled in rupees. Previously, under RBI’s exchange control regulations, international trade (except for those done with Nepal and Bhutan) has to be settled in fully convertible currencies such as the US dollar, the Sterling Pound, Euro, and Yen. This latest notification allows trade to be billed and settled in Indian Rupee. The RBI has said this is to promote exports from India and because there is an increasing interest to trade in the Indian rupee. Experts have said that the trade-settlement mechanism is to further trade with Russia, which has been cut off from its dollar reserves in the US, UK, and the EU.
The move will allow India to bypass orders that prevent using a global currency such as the US dollar for trade with certain countries. For example, India has been willing to trade with Russia but several countries have imposed sanctions on its banks and restricted Moscow’s ability to carry out transactions in major currencies. A rupee settlement mechanism will allow India to bypass these sanctions and trade using the domestic currency.
Reasons behind it:
India’s forex reserves are healthy at $588.3 billion (as of July 8) which can cover nearly 10 months of imports, but the central bank has been generously spending from it to support the sliding Indian rupee–which the bank does by selling dollars. This is when India has been seeing a massive outflow of foreign portfolio investments and is seeing record trade deficits–in June 2022, the country’s trade deficit was $25.63 billion, which was more than 2.5x what it was in June 2021’s $9.6 billion.
Sensing which way the wind is blowing, the central bank had recently announced a few measures to preserve and even increase the forex reserves. It allowed banks to raise interest rates on foreign-currency-holding accounts of non-resident Indians. It doubled the external commercial borrowing limit under the automatic route to $1.5 in one fiscal year and allowed FPIs to invest in more debt securities. With the latest rupee settlement mechanism, if an exporting country is willing to accept rupee payments, then there will be less pressure on India’s forex reserve.
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Rupee drops to a new low
Meanwhile, the rupee dropped by 19 paise to close at its new low of 79.45 against the US dollar on Monday. The fall was due to high demand for dollars and outflow of foreign funds, analysts said. At the forex market, the rupee opened at 79.30 against the dollar on Monday. It witnessed a mid-day high of 79.24 and a low of 79.50 before settling at 79.45. The currency has now depreciated for three successive trading sessions.
How will it work?
1st another country has to express interest in setting up this mechanism, then its central bank and the RBI will set up a common pool of money putting in equal amounts. The central banks will authorize certain local banks to operationalize this trade-settlement mechanism; such banks on the Indian side will e called Authorised Dealer banks. The local bank in the other country will hold RBI’s money in their local currency and the bank in the Indian side will hold the other central bank’s money in rupees. That’s where the ‘Rupee Vostro Accounts’, comes in. Vostro simply means “your money in our account”, therefore ‘Rupee Vostro Accounts’ keep the foreign entity’s holdings in the Indian bank, in Indian rupees.
In its notification, the RBI said banks would need to take its permission before setting up the rupee trade settlement mechanism. For enabling the mechanism, banks would need to create special rupee Vostro accounts for the banks of the trading partner countries. A Vostro account allows a bank to hold money on behalf of another lender.
When an Indian trader exports, he/she can approach his/her regular bank, which will send the invoice to the Indian AD bank. The Indian AD Bank will debit the Rupee Vostro account and credit the money to the exporter’s regular bank, which will in turn credit the money to the exporter’s bank account. When an Indian trader imports, he/she will transfer the payment into his/her regular bank, which will then transfer that to the AD bank. The AD Bank will credit the Rupee Vostro Account, and the exporter from the other country will be paid through the authorized bank there and in the local currency.
In other words, Indian importers using this mechanism will be paying in rupees that will be credited into the Vostro account of the bank of the trading partner country against the invoices for the supply of goods or services. For Indian exporters, they will be paid rupees from the balance in the designated special Vostro account. Indian exporters can also be paid in advance in rupees under this mechanism.
But Before allowing any such receipt of advance payment against exports, Indian Banks shall ensure that available funds in these accounts are first used towards payment obligations arising out of already executed export orders/export payments in the pipeline.” In case, a bank of a trade partner country approaches an Indian lender to open a special rupee Vostro account, it must seek RBI’s approval. The Federation of Indian Export Organisations welcomed the provisions.
The central pool of money will thus be debited and credited as long as the mechanism is in place, and at regular intervals, the country that has the balance of payments in its favor will decide what to do with what is remaining in the pool. “The deciding country may want to invest this money in the other country, or it may want the balance to be remitted to them in whichever currency and at whatever exchange rate the two countries decide,” said Sahai.
He said that a similar mechanism was worked out with Iran years ago but it has become dormant since India decided to stop importing oil from Iran in 2019. “We had converted all our oil dues to Iran into rupees and Indian exporters were being paid from that account,” he said.
Going by RBI’s latest note, the whole process starts when a bank from another country approaches the AD bank in India and says something like ‘We’d like to set up a Vostro account for the rupee-settled trade’. Then the Indian bank will take that request to the RBI’s Foreign Exchange Department at the Central Office in Mumbai. The Indian bank has to ensure that the partner bank isn’t from ‘high risk and non-cooperative jurisdictions. The banks simply have to refer to the FATF’s list, which names jurisdictions that have “weak measures to combat money laundering and terrorist financing”.
Will, there be any Add benefits:
One, an exporter can receive advance payments in rupees through this mechanism. Two, if an exporter also imports from his/her overseas partner, then the exporter can ‘set-off’ or subtract the export receivable from the import payable. The balance would then be paid to the exporter. Three, these trade transactions can be supported with bank guarantees.
Exporters have raised another kind of concern with the government. Generally speaking, exports in rupees or in any currency other than given foreign currencies are not entitled to export benefits. So, the government should clarify whether exports in Indian rupees will get the same benefits. These benefits are substantial and they add to the competitiveness of Indian exports.” This had been done when the agreement had been reached between Iran and India.