What happened so far?
India and Russia have suspended efforts to settle bilateral trade in rupees, after months of negotiations failed to convince Moscow to keep rupees in its coffers. Russia is not comfortable holding rupees and wants to be paid in Chinese yuan or other currencies. This would be a major setback for Indian importers of cheap oil and coal from Russia who were awaiting a permanent rupee payment mechanism to help lower currency conversion costs.
The implications of this suspension are not clear, but some possible effects are:
- India may have to pay more for its imports from Russia, especially oil and coal, which have surged since Russia's invasion of Ukraine last year.
- India may lose its trade advantage with Russia, which is one of its largest trading partners and a strategic ally.
- India may face pressure from the US and other Western countries to reduce its dependence on Russian energy and arms.
- India and Russia may look for alternative ways to facilitate trade in local currencies or other mechanisms.
The current situation is that India has deep trade ties with Russia, and the rupee mechanism can help bypass the U.S. dollar and the euro for settlements. However, large Indian lenders have shunned the rupee mechanism and have not responded to Russian banks' requests to set up rupee trade settlements. Some transactions involving Russian firms have taken place recently using the rupee mechanism, but it is not clear how widespread or sustainable this practice is.
How Russia and India going to resolve the rupee mechanism?
India and Russia are trying to resolve the rupee mechanism by:
Exploring alternative payment systems: India and Russia are looking for other ways to facilitate trade in local currencies or other mechanisms, such as using the UAE dirham, the Chinese yuan, or the International North-South Transport Corridor (INSTC).
Increasing bilateral trade: India and Russia are aiming to boost their trade volume and diversify their trade basket, especially in sectors such as agriculture, pharmaceuticals, IT, and defence. This will help balance the trade gap and create more demand for rupees and roubles.
Engaging state-run banks: India and Russia are likely to allow four to five state-run banks to be involved in the rupee mechanism, as private banks have shunned the arrangement due to sanctions or compliance issues. The state-run banks will need approval from the RBI and other regulators to carry out the transactions.
How does rupee mechanism work?
The rupee mechanism works as follows:
- Indian importers can make payments in rupee, which will be credited into the special vostro account of the correspondent bank of the partner country. A vostro account is one opened by a bank in its home country on behalf of a foreign bank.
- Indian exporters will be paid from the balances in the designated vostro accounts for their exports to the partner country. They may also receive advance payment against exports in Indian rupees through the mechanism.
- The funds in the rupee account can be used by the export partner for trading with anyone who accepts rupees. They can also be invested in Indian government securities or other approved instruments.
- The exchange rate between the rupee and the partner currency will be market-determined and mutually agreed upon by both parties. The Reserve Bank of India will provide oversight and approval for the transactions.
What are benefits of rupee mechanism?
Some of the benefits of the rupee mechanism are:
Trade facilitation: This will also facilitate trade with countries like Russia which are facing sanctions. It will also help India promote exports and support increasing global interest in the rupee.
FOREX savings: India imports more than it exports so the country will also save foreign currency under the new arrangement. It will also help India pay for Russian oil rather than the dollar.
Rupee appreciation: The rupee is at a historic low against the dollar. The rupee mechanism will help stabilize the rupee and reduce exchange rate risk for Indian firms.
What are challenges for rupee mechanism?
Some of the challenges for the rupee mechanism are¹²³:
Lack of demand: Not many countries may be willing or able to accept rupees as a payment currency, especially if they have a trade surplus with India and do not have enough avenues to use or invest the rupees they receive.
Lack of infrastructure: The rupee mechanism requires a robust banking network and regulatory framework to facilitate the transactions and ensure compliance with anti-money laundering and other norms. The partner countries may not have such facilities or may face sanctions or restrictions from other countries or entities.
Lack of liquidity: The rupee is not a fully convertible currency and has limited access to global financial markets. The partner countries may face difficulties in converting the rupees they receive into other currencies or assets as per their needs or preferences.
Lack of stability: The rupee is subject to high volatility and depreciation due to various domestic and global factors. The partner countries may incur losses or risks due to exchange rate fluctuations or inflation. They may also face political or economic uncertainties in India that could affect the rupee mechanism.
How does sanctions affect rupee mechanism?
According to the search results, sanctions affect the rupee mechanism in the following ways:
Disrupt trade with Russia: The US and other Western countries have imposed sanctions on Russia for its invasion of Ukraine, which have cut off its access to standard cross-border payment platforms such as SWIFT. This has created difficulties for India and other countries to trade with Russia using dollars or euros.
Create opportunities for rupee trade: The sanctions have also prompted India and Russia to explore alternative payment systems, such as the rupee mechanism, to bypass the sanctions and facilitate trade in local currencies. India can benefit from cheaper oil imports from Russia and increase its exports to the Russian market.
Create challenges for banks: The sanctions have also made banks wary of participating in the rupee mechanism, especially those who have offices or dealings with the US. They fear that they may face penalties or restrictions from the US authorities for violating the sanctions or compliance norms. This has limited the number of banks that can offer the rupee mechanism services.
How can India Russia avoid sanctions?
According to the search results, India and Russia can avoid the sanctions by:
Using alternative currencies: India and Russia can use other currencies, such as the UAE dirham, the Chinese yuan, or the Indian rupee, to settle their trade transactions and bypass the use of the US dollar or the euro, which are subject to sanctions.
Diversifying trade partners: India and Russia can expand their trade relations with other countries that are not part of the sanctions regime, such as China, Iran, Turkey, or Venezuela. This will help them reduce their dependence on Western markets and sources of finance.
Strengthening strategic ties: India and Russia can enhance their political and security cooperation, such as through the BRICS group, the Shanghai Cooperation Organization, or bilateral dialogues. This will help them counter the Western pressure and leverage their mutual interests.
What are the risks of using alternate currencies?
Some of the risks of using alternative currencies are:
Volatility: Alternative currencies, especially cryptocurrencies, are subject to extreme price fluctuations, which can cause investors to lose significant amounts of money in a short period of time. The exchange rate between alternative currencies and fiat currencies can also vary widely and unpredictably.
Regulation: Alternative currencies may face legal and regulatory challenges from governments and authorities, who may ban, restrict, or tax their use or transactions. This can create uncertainty and compliance issues for users and businesses that deal with alternative currencies.
Security: Alternative currencies may be vulnerable to hacking, theft, fraud, or loss due to their digital or electronic nature. Users may lose access to their funds if they forget their passwords, lose their devices, or fall victim to malware attacks. They may also face difficulties in recovering their funds or seeking legal recourse in case of disputes or errors.
Liquidity: Alternative currencies may have limited liquidity and availability, as they may not be widely accepted or traded by other parties. Users may face challenges in converting their alternative currencies into fiat currencies or other assets as per their needs or preferences. They may also incur high transaction costs or fees for using alternative currencies.