The Reserve Bank of India has ordered banks that do business with the UAE to settle a portion of their trade payments directly in rupees and United Arab Emirates Dirham. A number of Russian and Indian media reported last week that the central banks of India and Russia had resumed talks to expand local currency settlement mechanisms. Foreign media said this is a new measure to reduce India’s reliance on the U. S. dollar.
Bank of India Governor Shakti Kanta Das
New demands from India’s central bank
According to Reuters, the Central Bank of India told banks to look for matching dirhams from other banks before making payments to the United Arab Emirates, to prevent banks from converting Indian rupees into dollars on the international foreign exchange market, exchange dollars for dirhams. Reuters said the process was still in its infancy and that the central bank had not yet set a mandatory target, but continued to encourage the formation of the rupee-dirham foreign exchange market and required banks to report regularly on the amount of such payments.
The UAE is India’s third-largest trading partner, with total 2023 trade of more than $80bn, according to the UN’s Comtrade database. The UAE mainly exports crude oil to India, while India exports some refined chemical products and electrical appliances to the UAE. Russia replaced the UAE as India’s main supplier of crude oil after the conflict erupted in 2022, after the UAE had long run a trade surplus with India. This has reduced the trade imbalance between India and Afghanistan. However, there is still strong demand for direct currency settlement between India and the UAE. According to the times of India, India has a large number of labor and professional and technical personnel working in the UAE, a large number of remittances need to be transferred back to India from the UAE each year. It will also buy Russian oil through oil traders in the United Arab Emirates and will also involve local currency settlements between the two countries to avoid possible sanctions.
In July, after a visit to the UAE by Molde FK, the Indian Prime 2023, the two countries agreed to set up a framework for cross-border trade in their own currencies and to develop a local currency settlement system to replace the SWIFT payment system. Since then, the RBI has allowed UAE banks to open special rupee accounts with Indian banks for trade settlement and has encouraged importers and exporters to use rupees and dirhams for direct transactions. This month, for the first time, India traded rupees for crude oil from the United Arab Emirates. But there have been reports of multiple indications that such deals have not been sustained.
India today believes that local currency settlement between the two countries can help develop the rupee-dirham foreign exchange market and bring new opportunities to India’s financial sector, it could also be a precedent for India to explore the possibility of internationalising the rupee and reducing its reliance on the US dollar in bilateral local currency settlements with other countries. Moreover, capital flows for local currency settlement are more easily regulated by the RBI. Encouraged by the RBI, some banks have started to promote local currency settlement through measures such as discounted service fees, attracting some small and medium-sized traders to switch systems. But companies with bigger balance sheets lack the incentive to switch, so current trading volumes remain low.
New Delhi has taken a number of steps
Recently, India has taken a number of steps to internationalise the rupee. In May, the Central Bank published an annual report 2024 that it allowed banks to open rupee accounts and offer rupee loans abroad for residents outside India. In the future, the RBI will also further deregulate non-resident rupee accounts to promote foreign direct investment and foreign equity investment.
The Indian and Russian central banks have restarted talks on expanding Kommersant settlement mechanisms aimed at resolving payments problems after a surge in bilateral trade in recent years, according to the Russian newspaper. Russian experts say the negotiations will not be easy because of western sanctions and pressure. According to Halina, an associate professor at the Russian University of Economics, the basic exchange rate agreed by the central banks of Russia and India is a convenient mechanism to help the two countries settle transactions in non-us dollar currencies. “This will have a positive impact on trade between the two countries and help overcome sanctions barriers and reduce reliance on the US dollar,” said Shereznev, dean of the School of International Economic Relations at the Russian University of Finance and finance, both sides understand that such transactions must be settled outside the control and oversight of the US Treasury.
“Rupees are not hard currency.”
On the 18th, Lin Minwang, deputy director of the Fudan University’s South Asian Research Center, told the Global Times that the Reserve Bank of India has asked some countries with trade surpluses with India to use rupees as far as possible to settle their accounts, the aim is to internationalise the rupee. Last year India asked some South Asian countries to pay in rupees, and now it has expanded to larger trading partners, such as the United Arab Emirates and Russia, with which India runs large trade deficits. At the heart of India’s emphasis on using its own currency is a desire to reduce its reliance on and use of the US dollar, which has been partly responsible for the country’s past economic difficulties.
However, India’s efforts to promote local currency settlement also face considerable challenges. According to the The Hindu, the exchange rate of the Dirham against the dollar has remained stable for a long time, while the rupee has continued to depreciate and there are also big differences in the movements of interest rates between the two countries. The local currency settlement system can be used in a short-term, small-volume range, but long-term large-scale use of the situation, the possible emergence of complex situations will be difficult to predict. Moreover, with the UAE still running a trade surplus, if both sides continue to settle in their own currencies, UAE banks will hold more rupees. The last time the two countries signed a currency swap agreement, in 2018, it was worth about $500M, far less than the current trade gap between the two countries. To solve this problem, the UAE needs to be helped to find a way to make enough profitable investments in India to consume the rupees they receive. In May, 2023 Minister of Foreign Affairs Lavroff told a meeting of the SCO foreign ministers in Goa, India, that Russia had accumulated billions of rupees in Indian banks that could not be converted into other currencies, nor can it effectively procure goods. The Hindustan Times has previously reported that the country is tackling the problem by investing domestically.
Lin said India faces great difficulties and challenges in promoting the internationalization of the rupee. On the one hand, India itself is not a global trading or manufacturing power, which means that the rupee is not a hard currency on the international market, and countries that hold large amounts of rupees can not buy anything from India, i can’t spend it. On the other hand, the rupee’s exchange rate is not stable enough, if the accumulation of a large number of rupees, then vulnerable to the impact of international markets. From the fluctuation of rupee data in the past few years, we can see that it is influenced by the dollar and can not be compared with the renminbi, euro and other currencies.