Learn about the challenges and opportunities associated with the internationalization of the Indian Rupee, including Vostro accounts, trade settlement mechanisms, and the impact on the Indian economy.
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In July 2022, the Reserve Bank of India (RBI) introduced a mechanism for the “international settlement of trade Indian rupee,” marking the beginning of the internationalization of the Indian rupee. The RBI’s move was aimed at facilitating bilateral trade with Russia, which was facing sanctions from the United States. In December 2022, India used the Indian rupee to make its first successful trade with Russia.
Due to the Indian rupee’s internationalization, both Indian citizens and non-citizens can now freely use it in foreign markets, including for international trade and as a reserve currency. According to a report on money and finance that the RBI put out earlier this year, it was inevitable that the Indian rupee would be used around the world.
The SBI ECOWRAP report says that internationalizing the Indian rupee is very important, especially since capital is leaving emerging markets, which is making their currencies fall. The report talks about how important it is for India to make the rupee a global currency so that it doesn’t lose value.
On 11 July 2022, the RBI allowed the settlement of trade in rupees for the import and export of goods and services. Initially, this was intended to save bilateral trade with Russia from US sanctions. But soon, other countries started to be interested in the system. In the end, 35 countries in Asia, Africa, and Scandinavia said they were interested in using the Indian rupee to settle trade.
The rupee trade settlement mechanism is good for countries that don’t have a lot of US dollars or that can’t use the US dollar because of sanctions. Countries with severe shortages of USD, like Russia, Belarus, Iran, and Sri Lanka, are pushing for this mechanism.
The value of the Indian rupee is going down because India’s net imports keep putting pressure on its foreign exchange reserves. This is why the Indian rupee was the worst-performing Asian currency in 2022, falling by around 10% against the USD. However, if the flow of the Indian rupee in international trade increases, the outflow of USD will decrease, and the depreciation of the Indian currency will become more manageable.
Experts believe that the internationalization of the Indian rupee as an alternative to the USD in international trade will reduce India’s trade deficit. The growth of global acceptance of the Indian rupee resulting from increased international trade in the currency will also play a significant role in the Indian economy’s development. India will be able to do this on its own, unlike China, which is trying hard to artificially make its currency accepted around the world.
How does it work?
The internationalization of the Indian rupee is a significant milestone for India’s economy, as it allows the country to use its currency as an alternative to other major currencies like the US dollar, euro, and yen. In simple terms, the mechanism works by allowing countries to settle their import and export transactions in Indian rupees instead of relying on other global currencies.
When a country engages in international trade, they have to make payments in foreign currency, which is widely accepted across the world. The US dollar is the most important reserve currency right now, and most transactions are settled in dollars. This means that if an Indian buyer purchases a product from a French seller, the Indian buyer has to convert their Indian rupees into US dollars, which the French seller then has to convert into euros to use. This process costs money and puts both parties at risk of the exchange rate changing, which makes trade harder and more expensive.
The rupee trade settlement mechanism seeks to simplify this process by enabling both parties to open Vostro accounts, which allows them to trade in Indian rupees instead of US dollars. If the partner country has a Vostro account, the invoices will be released in Indian rupees, which eliminates the need for currency conversion, saving both parties time and money.
What is a Vostro Account?
A Vostro account is a special account that enables exchange between two countries, facilitated by an Indian bank with corresponding banks in other countries. It enables foreign exporters to be compensated in Indian rupees, which they can then use to import from or invest in India. Conversely, Indian importers have to make payments in Indian rupees, which will be credited to the partner country’s Vostro account.
To open a vostro account, any bank from a partner country can connect with any Indian bank, which must secure approval from the Reserve Bank of India. Once approved, the Indian bank can set up a special rupee vostro account for the partner country’s bank. This enables partner countries to settle bilateral trade in Indian rupees.
Keeping trade balances can be hard, though, because India buys more from some countries and sells more to others. In the case of a partner country exporting more to India, its rupee reserve may result in a surplus of Indian rupee. To address this, India has been partnering with smaller countries to develop rupee-based mechanisms so that these countries can accept trade settlement in Indian rupee with Indian partnering countries.
These smaller countries can use the Indian currency to trade with India, helping to develop a USD-like trade network at a smaller scale. This will not only spread Indian rupee trade settlement between India and partner countries but also between partnering countries and these smaller countries. This will provide a massive boost to the Indian rupee’s global acceptance.
Recently the Reserve Bank of India (RBI) has permitted banks from 18 countries to open Special Vostro Rupee Accounts (SVRAs) to settle payments in rupees, the government said. Speaking in Rajya Sabha, Union Minister of State for Finance Bhagwat Kishanrao Karad said that 60 such approvals have been given by the RBI
These 18 nations include Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, Myanmar, New Zealand, Oman, Russia, Seychelles, Singapore, Sri Lanka, Tanzania, Uganda and the United Kingdom.
What are the complications?
While the idea of rupee internationalization is exciting, it is also complex and presents several challenges. It may reduce cross-border trade and investment costs and exchange rate risks. But trade between two countries depends on a lot of things, like the political and economic relationships between the two countries, the availability of goods, their quality, how competitive their prices are, and the exchange rates.
Also, India’s share of world trade is not used to its full potential, and the country still imports a lot of fossil fuels, edible oils, gold, and silver. Experts believe that strong incentives are required for foreign exporters to use the Indian rupee as the settlement currency.
To make the Indian rupee a highly tradable currency, India must intensify its export and import trade and undertake critical reforms, such as strengthening financial markets. In this scenario, the complexity of Indian monetary policy formulation may increase. Therefore, it is essential to address the challenges and implement these measures in sync to tap the full potential of rupee internationalization.
In conclusion, the rupee trade settlement mechanism is a very important step in making the Indian rupee an international currency. This will help India’s economy grow. The use of Indian rupees as a global currency for trade settlement will reduce India’s dependence on other major currencies, particularly the USD. This move will also help India deal with the problem of capital leaving the country, protect its currency from falling in value, and cut down on trade deficits.
With Vostro accounts, India can trade with other countries using its own currency. This reduces the costs of converting money and the risks of the exchange rate changing. But keeping trade balances and managing the Indian rupee reserves that are more than needed is hard and needs creative solutions.
Even though there are problems to solve, the internationalization of the Indian rupee gives India’s economy a big chance to grow and compete on a global scale. Since more and more countries want to use the Indian rupee to settle trade, India needs to keep putting money into creating an environment that helps the rupee grow as a global reserve currency.
The views expressed in this article are those of the author alone and not the WorldRef.
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