Time will tell the extent to which the rupee gets internationalised

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The Reserve Bank of India (RBI)’s July 11 announcement to allow cross-border trade settlements in Indian rupees comes at a time when the currency is under continuous pressure. The measures follow a series of other steps that have broadly aimed at fortifying India’s external balances, and stabilise the weakening currency.

Apart from a strengthening US Dollar, the country-specific sources of exchange market pressure include a widening trade deficit driven by costlier imports of energy (oil and coal) and gold, slowing export growth, and net outflow of portfolio capital for several months. So, it elicits some wryness when the RBI says the rupee settlement mechanism endeavours to facilitate export growth, and global trade as well as ‘support the increasing interest of global trading community in INR’.

Irony apart, the rupee settlement of international trade does represent a step towards currency internationalisation, just as the ‘masala’ or rupee-denominated bonds launched in 2015-16 were. In the new domestic currency trade framework, exports and imports can be denominated and invoiced in rupees at a market-determined exchange rate, through special rupee (Vostro) accounts, while any surpluses after offset are permitted to pay for projects and investments in government securities.

Time will tell the extent to which the rupee gets internationalised as a result of this move. Going by the experience of masala bonds, it is worth noting that their issuance has remained a very minor and insignificant fraction of overall external commercial borrowings; it gathers momentum at times of currency appreciation (e.g., 2016-17) and falls back in the converse situation. Masala bonds have neither promoted or popularised the rupee’s global usage, nor matched up to expectations of a meaningful hedge against currency risk, or the emergence of an offshore rupee yield curve.

Both avoid the currency risk albeit at a premium. The bond investor takes it on in the case of masala bonds; hedging costs for rupee exposure have been high. In the rupee trade settlement framework laid out by the RBI, the exchange rate between the two trading partner currencies will be market determined. Here, there could be issues about overvaluation and implicit/explicit benchmarking of any bilateral exchange rate to a numeraire, the US Dollar.

This used to be an issue in the rupee-rouble trade with the erstwhile USSR; whichever country’s currency was more overvalued relative to a third currency (USD) lost from the rupee trade (Russia mostly at the time). Presently, Russia runs a current account surplus — this shot up to $138.5 billion in the first six months of 2022, up from corresponding $39.7 billion last year! India, by contrast, runs a perpetual current account deficit with robust capital inflows driving periodic overvaluations, which are never fully corrected in line with trade balances.

The rupee-rouble trade comes to mind because of the imminent triggers and its longer context. There’s been talk of reviving the bilateral rupee-denominated trade since the Russian President’s visit to India in November 2015 (and of the Indian Prime Minister to Russia in 2014) though nothing came of it. More recently, it’s been reported the central bank was examining the institution of such a trade system. A bilateral trade and payment-clearing agreement could have given rise to multiple currency practices, which are specifically disallowed under Article VIII of the IMF; these are seen to disrupt trade, distortionary (e.g., increased imports exchanged for increased exports, segmented markets, etc.), and to stimulate unjustifiable competitive practices among countries.

The timing of these measures in a backdrop of India’s fast rising imports of Russian crude oil, fertilisers, and growing currency pressures, the ongoing macro adjustments in the world economy due to inflation and repricing of rates that will likely be prolonged, and some permanent changes in several aspects across countries are factors indicating the chief motivation is easing energy import pressures than internationalisation.

Many have pointed out this overcomes the sanctions against the use of the USD or another global currency and banks for trade with certain countries. That the rupee settlements of international trade are expected to take out some dollar demand from the forex market over time. It remains to be seen if these steps contribute to reduced pressure upon the external accounts and currency. The convertibility of the rupee can hopefully follow the gain in stability.

Renu Kohli is a New Delhi-based macroeconomist. Views are personal, and do not represent the stand of this publication.