An expedient move
The Reserve Bank of India’s (RBI) move to permit the invoicing, payments and settlement of exports and imports in rupees is aimed at preventing dollar outflows and addressing the immediate liquidity mismatch in the local dollar market. That, in turn, is expected to slow the depreciation of the rupee. To be sure, the arrangement is expected to play out largely in the India-Russia trade corridor. At this juncture it seems highly unlikely New Delhi’s trading partners in the developed world would be comfortable accepting rupee receipts in lieu of hard currencies. To that extent, it’s not as though the rupee is going to become internationalised or a widely used currency anytime in the near future. However, by not specifying any countries with which payments and settlements in the rupee would be permitted, India is being politically correct. At the same time, the policy leaves the door open for a rupee-based payments mechanism with other countries —Sri Lanka, for instance.
RBI’s immediate objective is, of course, to enable importers to pay for expensive oil and coal in rupees, thereby preserving dollar assets. As is known, India has been importing more crude oil from Russia post the sanctions imposed on it in the wake of hostilities with Ukraine. If these can be paid for in rupees, it would help narrow the trade deficit, which, in May, bloated to $25.6 billion. From Russia’s point of view, the export proceeds, earned in rupees, would not be big enough to impact its reserves.
The mechanism, therefore, should work out, given the good political relations between the two countries. However, it’s not clear just yet how many of the Indian banks would want to facilitate rupee trade and it might take more than a nudge from the government to get them going. Bankers have also highlighted a potential problem in that the importing country’s banks may need to buy rupees from the market in the event their special Vostro accounts don’t already have a rupee balance. This, should, however, not be an issue in the case of Russia. Moreover, it’s a good move on the part of the central bank to allow the rupee balances in the special Vostro accounts to be used for various purposes; the funds can be used to pay for projects and investments, to manage the advance flows for exports and imports. The balances can also be invested in government securities and treasury bills, which would earn relatively high interest rates.
Should the arrangement work, it would help prevent dollar outflows and help the central bank address the mismatch in the market where demand for dollars from importers is outstripping the supply from exporters and where the situation is being exacerbated by portfolio outflows. While the RBI is supporting the market, much of the dollar sales seem to be in the forward market rather than in the spot market. The trade facilitation measures follow the central bank’s moves last week to ease the rules to attract dollar deposits and foreign portfolio flows (FPI). While there could be some inflow of dollar deposits, it might not meaningfully help stem the depreciation of the rupee. Right now the rupee’s trajectory is being determined more by the strength of the dollar index, which on Tuesday hit a new high of 108. Nonetheless, it’s worth exploring ways to bring in the dollars.