India’s central bank, the Reserve Bank of India (RBI), has asked the government to raise the cap on foreign banks making use of “vostro” accounts to purchase short-term sovereign debt. This would enhance rupee-denominated trade and investment, two sources and a letter to Reuters said. Local banks hold vostro accounts on behalf of foreign banks for them to have rupee-denominated balances arising from trade transactions.
In 2022, foreign banks were permitted by the RBI to open Special Rupee Vostro Accounts (SRVAs) for settlement of trade in rupees. This was an extension of India’s general initiative to internationalize the rupee. The owners of SRVA can invest in government paper without being foreign portfolio investors (FPIs) but the government placed a cap, limiting 30% of account balances for buying securities with residual maturity below one year, including treasury bills.
RBI plans to ease investment rules for Special Rupee Vostro Account holders by exempting them from the 30% cap on short-term government bonds, aiming to boost rupee trade, foreign investment, and financial ties.
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Challenges of the Existing Cap
The 30% cap was designed to promote long-term capital inflows and ensure financial stability. The cap, however, currently poses a huge challenge to SRVA holders. The limitation affects those who require immediate access to money since they usually deal with short-term liquidity. According to one source with knowledge of the issue, SRVA holders tend to need easy access to capital, which the existing cap fails to provide.
To deal with these issues, the RBI has suggested removing the cap in a letter to the finance ministry. The central bank opines that relaxing this limitation would promote wider participation in the SRVA mechanism, furthering India’s rupee internationalization process.
Implications for India’s Financial Market
The last word lies with India’s finance ministry. In the words of a second source, easing the cap may invite more players to employ SRVAs. This would improve India’s standing in international trade and finance. As many countries as 30 have opened 123 correspondent banks that have established 156 SRVAs with 26 Indian banks to increase bilateral trade using local currencies.
As of December 2024, the aggregate balance in all vostro accounts, including SRVAs, was 134.55 billion rupees (approximately $1.60 billion). The RBI recently also allowed overseas branches of authorized banks to open rupee accounts for non-resident individuals, enabling smoother settlement of current and capital account transactions.
Moving Towards Currency Globalization
India’s plan to ease investment conditions for foreign banks would make the rupee a stronger global currency. By lifting the cap on SRVAs, India would see increased international participation, enhancing its financial integration and cross-border trade.
Although the decision is in the hands of the finance ministry, this step is in line with India’s long-term objectives of increasing the rupee’s global role and financial market efficiency.
