RBI’s move is an initial step to reducing reliance on the dollar for foreign trade transactions.

With an emphasis on promoting exports from India and encouraging foreign trade in Indian currency, the Reserve Bank of India (RBI) on Monday announced an additional arrangement for invoicing, payment, and settlement of exports/imports in INR. This came on the backdrop of depreciating INR against the dollar amidst the widening of the trade deficit resulting in more demand for the dollar against INR.

How will the new mechanism work?

Authorized Dealer (AD) Bank would be now required to put in additional arrangements for export and import transactions in rupee. First, they would be required to have prior approval from the Foreign Exchange Department of the RBI. For settlement of trade transactions with any country, AD bank in India may open a special rupee vostro account of correspondent bank/s of the partner trading country. A Vostro account is an account a correspondent bank holds on behalf of another bank.

Indian importers operating under this mechanism would make payment in INR for their imports which would be credited into the special vostro account of the correspondent bank of the partner country against the invoices for the supply of goods or services from the overseas supplier. Indian exporters undertaking exports of goods and services through this mechanism would be paid the export proceeds in INR from the balances in the designated special vostro account of the correspondent bank of the partner country.

Importers and exporters of the partner countries would also make and receive their respective payments in their own domestic currency and transaction would go through the nostro account of the Indian AD bank. A nostro account is a bank account that a bank holds with a foreign bank in the currency of the country where the funds are held.?

The exchange rate for the transaction can be market-determined. According to the RBI notification, the surplus in the vostro account can be used for permissible capital and current account transactions such as payments for projects and investments or can be invested in government treasury bills and securities or for Export/Import advance flow management.

Past examples

India had a similar kind of arrangement with the USSR and the Eastern European Socialist block under the 1953 Indo-Soviet trade agreement. All the payment transactions under this agreement were supposed to be made in the INR. As a hedge against any fluctuation of INR, the INR value was fixed in terms of gold which later led to a lot of complications. Very recently, India had a similar bilateral Rupee-Rial arrangement with sanctions-hit Iran, and even as of now India is trading with sanctions-hit Russia based on a similar Rupee-rubel arrangement.

Impact

The said announcement by RBI comes at a time when many Asian countries such as UAE, Indonesia, and Myanmar are rumored to be in talks with each other to settle trade in their domestic currencies. This rupee trade mechanism by RBI can be viewed as a step towards the same. This should help reduce volatility in India’s exchange rate against the dollar as a settlement in the rupee would result in less demand for the dollar. This also has the potential to become a platform for India to trade with sanctions-hit countries such as Russia and Iran bypassing the SWIFT mechanism.?