RBI allows international trade settlement in Rupee

The Reserve Bank of India (RBI) decided to put in place an additional arrangement for invoicing, payment, and settlement of exports/ imports in Indian Rupee (INR) in the backdrop of the domestic currency sinking to a fresh closing low of 79.4375 per Dollar (USD) due to FPI equity outflows and a strong USD.

What is international trade settlement in rupees?

When countries import and export goods and services, they have to make payments in a foreign currency. Since the US Dollar is the world’s reserve currency, most of these transactions are entered into US dollar

How will the INR Rupee Based Trade Work?

Currently, when you trade in USD, even with Sri Lanka, the transaction happens in US banks. Why? because USD can only be held in a US bank. Every bank in the world  has accounts in US banks, and they just transfer money between each of those accounts when a trade settlement happens.

Here’s an example to understand this concept

 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 will then be converted into Euros.

Here, both the parties involved have to incur the conversion expenses and bear the risk of foreign exchange rate fluctuations.

This is where trade settlement in rupees comes in – 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 a Vostro and Nostro account?

To accept payments in rupees, authorized dealer banks will be able to open special Rupee Vostro accounts

A Rupee Vostro account is a foreign bank’s account with an Indian bank in rupees in India.

For example, HSBC holding an account with the State Bank of India in the Mumbai branch, denominated in rupees, is called a Rupee Vostro account.

Foreign parties will be able to send and receive money from Indian exporters and importers via these Rupee Vostro accounts.

On the other hand, a Nostro account refers to an Indian bank’s account with a foreign bank in foreign currency in the foreign country. It’s like SBI holding an account with HSBC in London, denominated in British Pounds.

How this will help India national Currency (INR) ?

It will promote the growth of global trade with emphasis on exports from India, and support the increasing interest of the global trading community in INR.

At a time when many countries in Africa and South America are facing forex shortages, the move allowing exim transactions through letter of credit will help exporters and importers.

It will reduce the impact of dollar outflows as a result of imports and thereby preserve foreign currency reserves.

This mechanism may enable Indian exporters to receive advance payment against exports from overseas importers in rupees.

How it will work?

Indian importers shall make payments in INR, which shall be credited into the special vostro account of the correspondent bank of the partner country against the invoices for the supply of goods or services from the overseas seller/supplier.

Indian exporters shall be paid the export proceeds in INR from the balances in the designated special vostro account of the correspondent bank of the partner country.

The rupee surplus balance held can be used for permissible capital and current account transactions in accordance with mutual agreement.

The balance in special vostro accounts can be used for payments for projects and investments, export/import advance flow management, and investment in government bonds.

How much will India save with this decision?

According to the latest trade data, India’s imports from Russia stood at $2.5 billion in April and May. This annualizes to $30 billion, and experts suggest it could increase to as much as $36 billion annually.

In the best-case scenario, if India pays for all of its Russian imports in rupees, it would end up saving $30-36 billion in dollar outflows.

For context, the RBI recently spent $40 billion in keeping the Rupee stable, and it could spend another $40 billion.