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Context

• International trade in the domestic currency will help reduce transaction costs for the industry and several countries are in discussion with the RBI on this - Commerce and Industry Minister said.

Background

• Last year, the RBI and Finance Ministry asked the top management of banks and representatives of trade bodies to push export and import transactions in the rupee.
• They want banks in India to connect with their foreign counterparts for opening special rupee vostro accounts to facilitate cross-border trade in the Indian currency rather than the popular mode of the U.S. dollar.
• RBI has allowed banks from 18 countries to trade in rupees.

CURRENT SYSTEM OF PAYMENT Currently, international transactions are mostly settled in foreign currencies, such as U.S. dollars, British pounds, euros, or yen. Payments in rupees are allowed only for some neighboring countries, like Nepal and Bhutan. Indian companies usually pay for imports in foreign currencies, while exporters get paid in foreign currency and convert them into rupees in most cases.

What is International Trade Settlement in Rupees?

• When countries import and export goods and services, they have to settle payments in a foreign currency. Since the US Dollar is the world’s reserve currency, most of the trade occurs in US dollars.
• For example, if an Indian buyer enters into a transaction with a seller from Germany, the Indian buyer has to first convert his rupees into US dollars. The seller will receive those dollars, which is then converted into euro.
• Here, both the parties involved have to incur the conversion expenses and bear the risk of foreign exchange rate fluctuations.
• With the help of a Vostro account now, instead of paying and receiving US dollars, the invoice will be made in Indian rupees if the counterparty has a Rupee Vostro account.

What is Vostro Account?

• Rupee Vostro Accounts keep a foreign entity's holdings in the Indian bank, in Indian rupees.
• When an Indian importer wants to make a payment to a foreign trader in rupees, the amount will be credited to this Vostro account, and when an Indian exporter needs to be paid for supplying goods or services, this Vostro account will be deducted, and the amount will be credited to the exporter's account.
• The exchange rate between the currencies of two trading partner countries may be market determined.

READ MORE ON VOSTRO ACCOUNT: https://www.iasgyan.in/daily-current-affairs/vostro-account-4

Which countries are likely to use this model?

• Exporters' bodies said RBI's move would help support trade with countries under sanctions, mainly Russia and Iran, and with African and South American countries - and neighbouring Sri Lanka - that have little access to hard currencies.
• The new Foreign Trade Policy (FTP) 2023 wants to thrust exports on the wheels of rupee invoicing that proposes both trading partners raising their invoices and settling payments for their transactions on a bilateral basis in rupees.

Exchange rate?

• The exchange rate between the Indian currency and those of trading partners is market-determined, and settlement takes place in rupees.
• Banks are allowed to provide letters of credits, and bank guarantees, and offer advance payments to exporters for trade transactions.

What are the benefits for India?

• This move will help reduce India’s dependency on US dollars. While this decision won’t have a considerable short-term impact, it will benefit the country in the long-term.
• Since India runs a trade deficit – its imports are greater than exports – settling trades in rupees will also save dollar outflows. At a time when the rupee’s value is declining every week against the US dollar, saving dollar outflows becomes even more critical for the RBI.
• Thus, RBI's move could marginally narrow India's widening trade deficit by reducing the price of commodity imports, analysts said, noting that imports of crude oil from Russia have surged in recent months.
• Circumventing the SWIFT payments system and paying for imports in rupees would also help India work around the sanctions imposed on its trade partners – Russia being the latest, and Iran is another prominent example from the past.
• International trade settlements in rupee are expected to gradually contribute to the global acceptance of the currency, and later make it possible to repay loans taken from fund banks like the Asian Infrastructure Investment Bank.
• Other benefits: Lowering of transaction costs, a greater degree of price transparency, Quick Settlement Time, promoting international trade, reduction in hedging expenses, reduced cost of holding foreign reserve by the RBI, and, most importantly, internationalization of the rupee.
• It will reduce India’s merchandise trade deficit and will help the country to export more. The exports will further increase as more countries join rupee trade.
• It is quite clear that it won’t stop the dollar hegemony but will definitely reduce dependency on US dollar to some extent. Demand of rupee will increase. It will contribute to the economy by saving dollar outflow especially when rupee is falling. Small exporters / importers may feel it easy to export or import in Indian rupees.
• It will reduce conversion cost for both the importers and exporters, thereby will influence the price of goods and may escalate their demand in the market. This can be better explained by supposing that an Indian buyer enters into transaction with a seller from Germany. The Indian buyer has to convert his rupees in US $, the seller will receive those dollars and convert it into euros. Both parties have to incur the conversion expanses and bear the risk of foreign exchange rate fluctuation. Herein comes rupee trade, instead of paying or receiving in US dollar the invoice will be made in Indian rupees if the counter party has a rupee vostro account.
• It will reduce demand for Foreign Exchange especially US$ in particular for the settlement of current account related trade flows.
• It will reduce currency risk for Indian traders.
• Protection from currency volatility will reduce cost of doing business and will allow better business growth and may provide chances for rupee to grow globally.
• It will reduce the need for holding foreign exchange reserves and dependence on foreign currency, making the economy less vulnerable to external shocks.
• But government officials said India would move cautiously on internationalizing the local currency given associated risks for the economy, such as high exposure to global shocks, asset bubbles, and exchange rate volatility.

PRACTICE QUESTION Q. The internationalization of trade in rupee is developing new vistas for Indian economy. It will be a great step in developing the foreign trade of the country. Do you agree?

https://www.thehindu.com/business/Economy/rupee-trade-arrangement-to-help-cut-transaction-cost-goyal/article66733879.ece