The US dollar is widely used in international trade and finance, with more than 70% of transactions using that currency. It also serves as the dominant reserve currency for central banks around the world. A dollar surge in 2022 had serious implications for the global economy. Many countries, including India, faced not only higher import prices, but also the rising cost of dollar-denominated debt. The difficulties were aggravated by US sanctions against the use of dollars in transactions with Iran and Russia. Importers and exporters in India were exposed to risks and turmoil in foreign markets, exchange rate volatility, and the depreciation of the Indian rupee.
India has been able to use a barter-like mechanism for trade settlements with Iran, with Indian oil refiners paying in rupees to local Iranian banks and the funds being used by Iran to pay for imports from India. Recently, India and Japan extended their bilateral swap agreements, now worth USD75 billion. The two countries can borrow from each other in either rupees or yen or use the US dollar. After this pact, India and Japan no longer have to use dollars to trade with each other. This move helps support the rupee as well as the yen against the dollar.
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In 2022 the government of India, promoting growth in global trade but with a focus on exports from India, allowed the rupee to be used in international settlement of imports and exports of goods and services. This reduced pressure on foreign exchange reserves held by the Reserve Bank of India (RBI). Before the change, export contracts could be denominated in freely convertible currencies or rupees, but export proceeds had to be in freely convertible currencies.
Following the RBI’s circular of 11 July 2022, settlement of trade transactions may now be made in rupees through special vostro (from the Latin for your) accounts (SVA) maintained by foreign banks at banks in India. Importers in India make payments in rupees into the SVA of the exporting country for their import of goods and services. For exports from India, payments are made in rupees from the balances in the SVA of the importing country. Importers and exporters in India need to use only rupees, with the banking system facilitating the conversion of foreign currencies through SVAs. The RBI has granted approval in 60 cases for domestic and foreign banks to open SVAs. The 18 countries involved include Germany, Israel, Kenya, Malaysia, New Zealand, Oman, Russia, Singapore and the UK. As an example, the India International Bank of Malaysia has opened an SVA with its corresponding bank, the Union Bank of India.
India’s foreign trade policy announcement of 31 March 2023 gave a further impetus to the trade in rupees by extending export benefits and incentives to rupee exports on a par with those for convertible foreign currency exports. The benefit of mechanisms such as the Export Promotion Capital Goods Scheme, Advance Authorisation, Duty Free Import Authorisation, Remission of Duties and Taxes on Export Products, and Duty Drawback now apply to rupee exports, including those to Iran. Rupee exports will also count towards the Status Holder Scheme and are exempt from goods and services tax. Introducing this policy, the commerce secretary explained that the rupee would be an alternative for countries affected by the monetary tightening policy of the US. India thus continues to transform the rupee into an international currency and thereby avoids the worst of global financial crises.
The use of the rupee will reduce the outflow of dollars from India and encourage the growing acceptance of the rupee as a global currency facilitating global trade. Importers and exporters will benefit from lower transaction costs, greater price certainty, quicker settlement times and a reduction in the cost of hedging against exchange rate fluctuation.
The invoicing and settling of trade in rupees and yen favours trading partners such as Japan, from which India imports on a large scale. Exports from India will benefit as well. While the swap agreement between India and Japan, concluded in 2018, has worked well for the two countries, financing trade by way of SVAs will create a more permanent mechanism for supporting the yen and the rupee. It will also promote trade between the two nations and insulate their economies from the volatility of the US market.
Reena Asthana Khair is a senior partner at Kochhar & Co.
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