In today's Finshots we see what the RBI approval to settle international trades in Indian rupees actually means

The Story

When Russia first invaded Ukraine in February 2022, western countries imposed a barrage of economic sanctions on the country. At the time, many chose to sever ties with Russia. This meant Russia couldn’t engage with countries the way it used to. And Russia’s biggest oil producers were locked out of many markets.

It was a desperate time.

And to keep the ship afloat, Russia started selling oil at a deep discount. They also found new trading partners — India, for instance. However, since the US had locked out Russia from accessing its dollar deposits, we consummated the transactions using rupees and rubles (Russian currency).

And this was a pretty big deal. Why’s that, you ask?

For starters, bear in mind that the dollar is the de-facto currency for international trade. Take India as an example. We import 86% of all the stuff we need using dollars. This, despite the fact that a mere 5% of our imports originate from the US. So we don’t usually trade with other currencies.

But when Russia came calling, we made a special exception. And it seems now we are making the exception a rule.

This week, the RBI decided to tweak a few things surrounding international settlements. And if somebody wanted to pay for Indian exports in rupees, we will honour that transaction. Sure, banks will still have to get the RBI’s approval first, but it’s possible.

How will this work, you ask?

Well, let’s look at how a simple international transaction works. Most trades are facilitated by banks in the US. So for instance, if India wanted to import oil from Russia, they’d ask Russia to furnish details about their US bank account. A bank account they may have set up to settle international transactions. Once we identify the account, India can then capitalize it using dollars and pay for Russian oil using these monies. Russia can then use the dollars deposited in the account to pay for other things.

But if you had to bypass the US altogether, you’d have to do a few things differently.

Let’s take a similar example, but just top it up with some extra details.

  1. Consider a Russian oil exporter. They will first approach one of their own banks and ask them to set up a special bank account in India called Vostro (which is Latin for “yours”).
  2. Now, since the account is in India, an importer looking to buy Russian oil can simply transfer Indian rupees into this Vostro account.
  3. So the Russian company will hold Indian rupees for now. But that seems pretty pointless, right? It needs rubles!
  4. And that’s when the banking partners will conjure up some magic. The Russian bank will assume an exchange rate and pay the exporters the rubles it needs.
  5. But wait…the Vostro account in India still has the rupees, right? What happens to that?
  6. Well, let’s assume there’s a Russian beverage company that wants to now import tea from India. It could pay the Russian bank in rubles. And the bank could use the rupees in the Vostro account to pay the Indian tea company.
  7. Also, if there’s excess rupees just lying idle in the Vostro account, the bank could invest it into Indian government bonds.

And while this scheme seems very interesting, the problems should be evident already.

The program only works if Russia has a massive need for Indian goods and services. It’s the only way they can put the rupees to good use. So if we are planning to export this program to other countries and bypass the US altogether, then we should hope that these other countries also have ways to put the rupees to good use. Otherwise, it’s a no-go.

Also, there’s a reason why RBI is pushing this program right now. The Indian rupee has lost a lot of value over the past few months. And some of it can be attributed to the fact that there simply isn’t enough demand for our currency. Foreign investors aren’t looking to park their money in India and our economy isn’t exactly booming either (for people to demand more rupees).

So one argument is that this could potentially help drum up more demand for our currency and hopefully alleviate the precipitous fall of the rupee.

But as Sanjeev Sanyal, a member of the Economic Advisory Council said in an interview, “Please don’t get too excited about the immediate ramifications of this.” We have to think about the big picture.

The short-term gains may not be too apparent. But perhaps this could be a harbinger for things to come. The final objective is to make the rupee a more acceptable currency and if things go according to plan, maybe we will see more trading partners actively use the rupee.

Until then…

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