India and Malaysia Agree to Settle Trade in Indian Rupees

• 03 Apr 2023

For Prelims: Trade Settlement in Rupees, ASEAN region, Reserve Bank of India (RBI), Special Rupee Vostro Accounts (SRVAs), India’s Forex Reserves, Monetary policy.

For Mains: Significance of India's Move to Settle Trade in Indian Rupee, Challenges Related to Internationalisation of Rupees.

Why in News?

India and Malaysia have agreed to settle trade in Indian rupees.This mechanism is expected to enhance India-Malaysia bilateral trade which touched USD 19.4 billion during 2021-22.

• Malaysia is the third largest trading partner of India in the ASEAN region, after Singapore and Indonesia that account for USD 30.1 billion and USD 26.1 billion bilateral trade with India respectively.

What is the Significance of India's Move to Settle Trade in Indian Rupee?

• About:
  • In July 2022, the Reserve Bank of India (RBI) allowed the settlement of international trade in Indian rupees.
  • In December 2022, India saw its first settlement of foreign trade in rupee with Russia – as part of the 'International Settlement of Trade in Indian Rupee' mechanism initiated by the RBI.
  • In March 2023, banks from 18 countries were allowed by the RBI to open Special Rupee Vostro Accounts (SRVAs) to settle payments in Indian rupees.
    • It includes: Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, Myanmar, New Zealand, Oman, Russia, Seychelles, Singapore, Sri Lanka, Tanzania, Uganda, and the United Kingdom.
• Benefits of Trading in Indian Rupees:
  • Controlling Depreciation of Rupees:
    • India is a net importer and the value of the Indian rupee has been declining consistently.
      • Using the rupee for international trade transactions will help check the flow of dollars out of India and slow the depreciation of the currency albeit to a “very limited extent.
      • Thus most importantly, the move is expected to reduce the pressure on India’s forex reserves.
  • Better Pricing for Goods and Services:
    • With the ability to invoice trade in Indian rupees, Indian traders can achieve better pricing for their goods and services.
      • Also, this mechanism is expected to benefit both sides of the trade by reducing currency conversion spreads.
  • Towards Global Acceptance of Rupees:
    • International trade settlements in rupee are expected to gradually contribute to the global acceptance of the currency, and later make it possible to repay loans taken from fund banks like the Asian Infrastructure Investment Bank.
• Challenges:
  • Volatility of the Indian Rupee:
    • The Indian rupee is known to be volatile and subject to fluctuations in the foreign exchange market, which may make it less attractive as a settlement currency for some international traders.
  • Complication in Controlling Domestic Supply:
    • RBI’s report warns that the ‘internationalisation’ of the rupee can potentially limit the ability of the central bank to control domestic money supply and influence interest rates as per the domestic macroeconomic conditions.
    • Ultimately, it may lead to complications in terms of formulating the monetary policy.
  • Competition with Other Currencies: The Indian rupee may face competition from other major currencies, such as the US dollar, Euro, and Yen, which are already widely accepted for international trade settlements.

What is a Vostro Account?

• It is an account that domestic banks hold for foreign banks in the former’s domestic currency, in this case, the rupee.
  • Domestic banks use it to provide international banking services to their clients who have global banking needs.
• The bank holding the Vostro account acts as a custodian of the foreign bank's funds and provides various services such as currency conversion, payment processing, and account reconciliation.

Conclusion

India's willingness to take concrete steps towards de-dollarisation of its international trade and to make the rupee a tradable currency is a significant step towards internationalisation of rupees. But India must increase its exports, supported by critical reforms that include capital account convertibility, deepening financial markets to manage the large-scale inflow and outflow of capital.

UPSC Civil Services Examination Previous Year Question (PYQ)

Q1. Convertibility of rupee implies (2015)

(a) being able to convert rupee notes into gold
(b) allowing the value of rupee to be fixed by market forces
(c) freely permitting the conversion of rupee to other currencies and vice versa
(d) developing an international market for currencies in India

Ans: (c)

Q2. With reference to Balance of Payments, which of the following constitutes/constitute the Current Account? (2014)

1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Rights

Select the correct answer using the code given below:

(a) 1 only
(b) 2 and 3 
(c) 1 and 3
(d) 1, 2 and 4

Ans: (c)

Source: TH