In an attempt to settle international trade in INR for export promotion schemes, the Indian government has made certain amendments in the foreign trade policy. On 11 July 2022, the RBI in a Circular (RBI/2022-2023/90 A.P. (DIR Series) Circular No.10), proclaimed a framework for cross border trade transactions in INR under Foreign Exchange Management Act, 1999 (FEMA) consisting of (a) Exports and Imports are to be denominated and invoiced in Rupee (INR); (b) Market determined exchange rate between the currencies of the two trading partner countries; (c) for settlement of trade transactions with any country, authorized dealer (AD) banks in India may open Special Rupee Vostro Accounts of correspondent bank/s of the partner trading country. Settlement in Vostro account for the importers will be done as importers shall make payment 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. On the other hand, 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. These measures have been justified due to the increase in interest in internationalization of Indian Rupee (INR), to promote growth of global trade with emphasis on exports from India and to support the increasing interest of global trading community in INR.
At present, the industry is optimistic of initiating full-fledged rupee trade with Russia, for which UCO bank is working on guidelines for putting in place the rupee trade mechanism. Interestingly, during 2015 after the imposition of sanctions on Iran due to its nuclear programme, UCO Bank was designated by the GoI as the payment bank for Iranian oil. UCO bank was selected as it did not have a foreign branch unlike many other banks. Signed in 2015 by Iran and several world powers, including the United States, the Joint Comprehensive Plan of Action (JCPOA) put considerable restrictions on Iran’s nuclear program in exchange for sanctions relief.
This rupee-ruble or such bilateral trade mechanism between Russia and India will be highly important as India’s bilateral trade with Russia between April and August 2022 climbed sharply to a record high $18.2 billion. As a trading partner also Russia’s position with India has enhanced at the seventh position compared to its 25th position last year, primarily driven by a surge in the import of oil and fertilizers as an aftermath of the war in Ukraine. For instance, in 2022 so far, fuel and fertilizers- these two items have constituted over 91 per cent bilateral trade between India and Russia. India also relies heavily on Russia for refined products. Russian oil is also relatively cheaper and of better quality unlike countries like Venezuela, as well as provided huge discounts to other countries including India during the period of sanctions imposed by US and other countries in Russia.
The two Tables in this article sourced from the Ministry of Commerce & Industry, GoI, show the imports of petroleum products as well as petroleum crude from Russia during April-August 2022, that compares the current years’ (2nd column) value with the previous years’ (3rd column) value, and it can be observed that from May-June 2022, the import from Russia of petroleum products and oil have increased substantially. The cumulative YOY growth has also shown a remarkable increase from last year.
Such bilateral based transactions settlement will be a prudent strategy provided the importance of the concerned trading partner and a careful assessment of a cost-benefit analysis with similar other trading partners (close substitutes). On the issue of whether India would be able to exploit benefits of rupee internalization further experimentation would be required and possibly a straightforward answer does not exist since such benefits would depend on country-specific characteristics. For instance, an Asian Development Bank Institute (ADBI) working paper titled as “The Benefits and Costs of Renminbi Internationalization” (ADBI Working Paper 481; Zhang, L., and K. Tao. 2014) found that in terms of the Chinese currency renminbi, one-unit rise in currency internationalisation is likely to increase the development of the financial market by 0.2 percentage points in terms of private credit and 0.7 percentage points in terms of stock market total value. One apparent benefit is the reduction in transaction costs, by reducing the exchange risks of global trade and investment.
However, given the differences between the economy of China and India, and given potential risk factors, it will be better for India to adopt a gradualist approach. An RBI Staff Studies in April, 2010, titled as “Internationalisation of currency: The Case of the Indian Rupee and Chinese Renminbi” has highlighted that unlike China, that normally runs a current account surplus, India generally runs a trade and current account deficits. Though, at the current juncture China is also facing many challenges due to its property issue and zero-covid policy, India has faced a downside in its external balances/current accounts in October 2022, as its export has declined 16.5% to $29.8 billion whereas imports has increased 5.8% to $56.7 billion resulting in a trade deficit of $26.9 billion (this was $17.9 billion in the last year). A concerning factor is that fewer countries like Netherlands, Brazil, and Singapore have shown export growth for the Indian market among the top ten destination during this month. Further, while electronic goods export has shown positive trend thanks to the thrust in domestic manufacturing, certain major exportable like gems and jewellery, engineering goods, chemicals, pharmaceuticals, and readymade garments have experienced a dip. On the import side, barring machinery and non-ferrous metals, petroleum and fertilizers have seen major growth with Russia emerging as a major source whereas the share of US, China and Australia have shown decline among the top ten major import sources for India. Another challenge that cannot be ignored is the volatility of the FII investments, for instance, while in October 22, FPIs bought shares worth nearly Rs 8,430 crore ($1 billion) against net selling of Rs 13,405 crore ($1.6 billion) in September 22. However, given that inflation is still globally a major challenge, Fed rate hike will continue albeit maybe in a moderate pace given the recently softened stance of the inflationary trend in US. Therefore, possible FII withdrawal from the Indian market in future cannot be ruled out.
In a nutshell, it can be argued that the recent gradualist approach for rupee internalization in a strategic manner is a reasonable approach while keeping in mind that Russia is a large strategic trading partner for India especially for petroleum products and crude oil. Further, Russian discounts on oil during the post-sanction period went up to $35/barrel. India needs to weigh strategically globally major oil suppliers like Russia, Iraq, Saudi Arabia, Venezuela among others parameterizing based on accommodation in line with its five-point agenda of being self-reliant in the energy sector. If India can view this as an opportunity of buying discounted oil from Russia at concessional terms, it can serve the purpose of saving the forex reserves that has come under pressure recently due to weakening rupee.
Vipin Malik is Chairman and Mentor, Infomerics Ratings; Sankhanath Bandyopadhyay is Economist, Infomerics Ratings; Athar Imam Raza is Officer Economic Analysis, Infomerics Ratings.