The Dollar’s status as the reserve currency was not established by mandate but rather as a result of the United States’ emergence as the largest economy in the world. The following are some of the main elements that make the dollar a reserve currency:
• Considered as safe-haven currencies
• Capacity to run enormous deficits
• Market’s size, liquidity, depth, and openness of the US financial
• The easiness of currency conversion,
• Establishment of the Petro Dollar system.
Following Russia’s invasion of Ukraine, the United States and its European allies imposed financial sanctions on Russian banks and organisations. While the US restricted Russia’s access to the US dollar, it also barred Russia from using the SWIFT payment system. Strike on Russian reserves was a genuine wake-up call for the majority of countries, who are now attempting to reduce their reliance on US currency and the SWIFT payment system.
Since a large portion of India’s fuel demand is met by imports, and 86% of India’s imports are invoiced in dollars. In this scenario, there is a significant need to reduce foreign currency for the settlement of trade flows related to the current account. When a country imports or exports merchandise or services across borders, the role of foreign currency is to facilitate transactions. Because the US dollar is the world reserve currency, the importer have to first convert their domestic currency into dollars before giving those dollars to the prospective seller.
Given these conditions over the years, and in light of recent sanctions, the Reserve Bank of India’s (RBI) notification on 11 July 2022 stating, “To promote (the) growth of global trade with emphasis on exports from India and to support the increasing interest of (the) global trading community in INR, it has been decided to put in place an additional arrangement for invoicing, payment, and settlement of exports/imports in INR,” was warmly received.
The decision to allow international trade in rupees will benefit not only imports but also exports. Trade in rupees is intended to facilitate trade with close trading partners who lack foreign exchange reserves or are unable to make payments in US dollars, such as Russia, Sri Lanka, and others. Rupee payments for imports would also enable India to bypass restrictions imposed on its trading partners, the most recent of which are Russia, Iran, and Venezuela. Because India is a net importer, allowing rupee trade will reduce India’s reliance on dollar foreign reserves.
In order to keep inflation under control, central banks around the world have recently raised interest rates. Under their mandate, the US Federal Reserve is raising interest rates, attracting investors to safe havens and causing shortage in the Eurodollar market. There is a significant need in this situation to reduce foreign currency transactions in order to save firepower for bad days. As a result of the significant increase in global commodities, particularly oil for imports, India’s trade and current account deficits have reached unsettling proportions. The situation demonstrates the impact of the strengthening US dollar on global trade prices and volumes. According to recent remarkets by India’s Finance Minister Nirmala Sitharman that “the Indian Rupee hasn’t weakened but in reality, it is the US Dollar that has strengthened.”
In terms of global politics, the action is significant because it signifies the beginning of more concerted efforts by the BRICS nations to settle payments in non-dollar currencies, with other South Asian and Middle Eastern countries showing interest as well. During these difficult times, when China and Russia are developing alternative payment systems, it will help strengthen Indian rupee’s position on the global stage.
To settle trade bills in rupees, international banks must open Vostro accounts in India for quick settlement. When trade settlement is done in rupees, the invoice will be made in Indian rupees if the counterparty has a Rupee Vostro account, rather than going through the process of paying and receiving US dollars or Euros.
What is Vostro account?
As per Wiki, a vostro account is a record of money held by a bank or owed to a bank by a third party. It allows domestic banks to offer international banking services to clients with such requirements. The domestic bank will act as the funds’ custodian, it also manages and supervises the client’s funds in the account, while the correspondent will keep the money. The services include wire foreign exchange transactions, deposit and withdrawal features, and international trade expediting.
Following its independence, India signed a number of bilateral trade treaties, including those involving rupee-based imports and exports to and from India. Increased interest in bilateral trade and investment will be dependent on trading partners’ willingness and negotiations to find a negotiable instrument/price that eases transaction pressure. RBI’s decision on the rupee settlement can facilitate trade with Russia and other sanctioned countries such as Iraq. Given that India has a trade deficit, the positive response from many countries to bilateral trade in INR may have a limited benefit at this time. As a result, truly internationalising the INR will take time.