Global trade in Rupees

Mains Marks Booster     5th August 2023        
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Introduction

The Reserve Bank of India's recent announcement of a new arrangement for settling imports and exports in rupees aims to boost global trade, with a focus on promoting Indian exports and meeting the growing interest of the global trading community in the Indian Rupee.

Background: Russia-Ukraine War

  • India, being a trade deficit country, imports more than it export, necessitating the maintenance of large forex reserves as international trade still primarily relies on US dollars.
  • The RBI has previously allowed international trade in rupees during the sanctions on Iran, resulting in trade between the two countries being conducted in rupees instead of dollars.
  • The ongoing Russia-Ukraine war and subsequent sanctions provide another opportunity for the RBI to advocate for trading in rupees.

US Dollar: The Global Currency

  • The US dollar has been the dominant global currency since World War II, with approximately half of international trade, loans, and global debt securities being denominated in USD.
  • The USD became the official reserve currency of the world in 1944 through the Bretton Woods Agreement.
  • Despite challenges faced by the US economy in the 1980s, such as fiscal and external deficits, the dollar's share of global reserves remained stable and even grew over time.
  • The dollar's dominance is supported by robust and credible institutions, deep markets, and its freely convertible nature.
  • Nearly 40% of the world's debt is issued in dollars, leading to a high demand for dollars by foreign banks for conducting business, as seen during the 2008 financial crisis.

Why such a move?

  • Trade facilitation: This arrangement will facilitate trade with countries facing sanctions, such as Russia.
  • Forex savings: India, as a net importer, will save foreign currency through this new settlement system.
  • Rupee appreciation: The rupee's historic low against the dollar can be stabilized through this initiative.
  • Mitigating war impact: Following the Russia-Ukraine war and the cutoff of Russia from the SWIFT payment gateway, exporters faced difficulties with payments, which this system aims to alleviate.
  • Convertibility easing: This move can be seen as a stepping stone toward achieving 100% convertibility of the rupee.
  • Energy security: Access to discounted crude oil from Russia, which constitutes 10% of all imported crude, is facilitated.
  • Export promotion: This mechanism will promote Indian exports effectively.

Which countries would prefer this system?

  • War-affected Countries: Trade settlements in rupees are expected to be limited to countries like Russia and Iran facing Western sanctions.
  • Economically challenged countries: Countries experiencing economic turmoil, like Sri Lanka, may benefit from this arrangement as India has been extending lines of credit to them.
  • Immediate neighbours: Other countries, particularly India's neighbouring nations, may also consider this system.
  • Preference for Rupees over Dollars: The preference for trading with India in rupees arises from the strength of the US dollar against most currencies worldwide, making imports expensive for many countries.
  • Sri Lanka’s example: Sri Lanka's economy has suffered greatly, with its currency falling 83% against the US dollar, while the fall against the Indian rupee has been comparatively lower at 70%.
  • Trade surplus countries' preference: The Indian government and RBI must address why countries with a trade surplus with India would want to trade in rupees.
  • Negative trade balance: China, with a trade surplus of $100 billion with India in 2022, would hold a significant amount of idle Indian rupees if it were to trade in rupees.

Way Forward

  • In a multipolar world with frequent Free Trade Agreements (FTAs), reducing the dominance of the dollar seems desirable for governments concerned about US global primacy, forming coalitions against it.
  • Sanctions against Russia may indicate a decline in the dollar's status as the reserve currency.

Conclusion

While this move will not dismantle the dollar's dominance overnight, the demand for the rupee depends on India's ability to export. Only if all nations collectively stop using the dollar will its significance decline.

Samadhaan