Author: Manya Gupta
Editors: Siddharth G. Khare and Soline Germond
The prevalence of the US dollar in international trade and finance is a well-known fact. The dollar runs the global economy, long enjoying the status of the world’s preeminent reserve currency since the end of World War II. With almost all currencies defined in relation to the dollar, the US occupies a dominant position from both economic and geopolitical standpoints, with decisions taken within the country shaping the global economy. However, this will likely change as emerging nations such as India find a way around doing cross-border business in individual currencies. What does the rupee’s onward journey look like, and what does it mean for the future of global trading?
Following its invasion of Ukraine, Russia was prevented from trading with the world as $300 billion worth of its foreign reserves out of the total of $640 billion were frozen through the “single largest sanctions action in modern history”. Burdened by heavy western sanctions, the country was cut off from the SWIFT Banking System tightly controlled by the US and Europe, facilitating over 50% of all cross-border transactions. This disconnect of Russia from SWIFT meant an inability to smoothly trade in major currencies such as dollars, euros, and pounds, hastening Russia’s financial decline and making it “the pariah” of the international financial system. But how do India and its rupee come into this chaotic picture? Given Russia’s importance as the largest oil supplier to India, the RBI announced the Rupee Settlement Mechanism in July 2022 to denominate trade with Russia in INR— this is just the beginning. As the dollar index increases sharply, imports have become costlier, with many countries looking for an alternative. Just like Russia, up to 35 other countries from Scandinavia, Asia, and Africa have shown interest in better understanding this new mechanism proposed by India for international trade settlement to reduce dependence on hard currencies and lower their conversion costs against high fluctuation in the foreign exchange rate. In fact, the RBI has approved the opening of 18 Vostro accounts, which are accounts held by a domestic bank, e.g. an Indian Bank, for a foreign bank, e.g. a Russian Bank, to conduct settlement in the domestic bank’s currency, e.g. rupee. Of these accounts, 12 belong to Russia, 5 to Sri Lanka, and 1 to Mauritius. The Indian government is now looking forward to bringing more countries that require liquidity support due to inadequate availability of dollars into the mechanism— Cuba, Luxembourg, Sudan, and Tajikistan have already entered talks with India. The country is also looking to trade in INR with its larger trading partners, like key oil suppliers and major west Asian players such as Saudi Arabia and UAE, with potential rupee-riyal and rupee-dirham trade mechanisms, respectively.
However, as India experiences a trade deficit with these countries, with imports far exceeding the level of exports, countries must find potential for further investment of the surplus of rupee in their Indian Vostro account back into India, e.g. in the Indian government security and bonds. And as the rupee is not a fully convertible currency that can be openly traded in the forex market, these investments cannot be repatriated, making the international trade in the rupee beyond the point of balanced trade challenging. Moreover, for a country’s currency to be ‘international’, it must be widely accepted as the medium of exchange across the world– this is why the US has such a tight grip on the financial systems and global economy. Countries may see non-dollar payments as bringing foreign exchange risks, hence preferring dollars in international transactions. Also, after the dollar, currencies such as the euro, yen, pound, Canadian dollar, and swiss franc occupy the spot of the most traded currencies, with the Indian rupee coming much after. Therefore, the internalisation of its currency may go a long way for India; however, it is a vital first step towards “de-dollarisation”, with the rupee fast emerging as a sort-after currency for bilateral trade settlements by a variety of nations. A global acceptance of the Indian currency, in the long run, would require changes in regulatory outlook as well as effective policy tools catered to macroeconomic risks, capital flows, and external trade to ensure smooth conduct of the foreign exchange market.
Also, India is simply one of many in this race. For example, India’s neighbour China continues to advance prospects for internationalising the Renminbi(RMB) to escape the “dollar trap” by deliberately devaluing its currency and artificially controlling the RMB exchange rate, thereby making its exports more competitive and raising its economic influence globally. However, this attempt to promote the use of RMB outside of mainland China appears to be failing against the tight capital controls within the country, which makes the Chinese economy less open and liberalised, restricting the free movement of the currency and making it less attractive to the rest of the world. These challenges demonstrate the hindrances that may lie ahead of India; hence the country must learn from others and create long-term plans to provide countries with substantial incentives to use its currency.
Overall, the Rupee Trade Mechanism is likely to strengthen the Indian rupee against the US dollar and slow down its depreciation by increasing its demand and hence value. Most importantly, it will weaken the dollar hegemony and allow developing nations such as India to gain economic self-sufficiency in the global currency market while easing pressures on its balance of payments by offering opportunities to finance its deficit with its own currency. This way, the mechanism supports national development initiatives like the “Make In India” programme, which facilitates investments and innovation in the domestic economy for economic growth and development.
Overall, whether or not the rupee becomes a “global” currency, a revolution in global trading is awaiting with changing nature of international exchanges within the global trading system. And the RBI freeing up the rules of the international banking system could be the start of it all!
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