PayKun Payment Gateway: To Reduce Dollar Dependence, India Lays Out Local Currency Settlement, UAE a New Target

Recently, the Reserve Bank of India (RBI) directed banks doing business with the United Arab Emirates (UAE) to settle some of their trade payments directly in Indian rupees and dirhams. Last week, several Russian and Indian media outlets circulated news that RBI resumed talks with the Central Bank of Russia on expanding the local currency settlement mechanism. The move is seen as part of India's strategy to reduce its dependence on the US dollar.

**New RBI regulations**

According to Reuters, the RBI has asked banks to bypass the international foreign exchange market link of converting Indian rupees into US dollars and then into dirhams by obtaining the corresponding dirham funds from other banks before making payments to the UAE. This process is still in its infancy and RBI has not set any mandatory targets. Instead, it continues to encourage the formation of a rupee-dirham foreign exchange market and requires banks to report the amount of such payments on a regular basis.

The UAE is India's third largest trading partner, with bilateral trade exceeding $80 billion in 2023, according to the United Nations Commodity Trade Statistics Database. The UAE mainly exports crude oil to India, while India exports refined chemicals and electrical goods to the UAE. While the UAE has historically enjoyed a trade surplus with India, the outbreak of the Russia-UAE conflict in 2022 saw Russia replace the UAE as India's top oil supplier, thereby narrowing the trade imbalance between the two countries. Nonetheless, there is still a huge demand for direct currency settlements between India and the UAE. The Times of India reports that a large number of Indian workers and professionals in the UAE repatriate large amounts of money to India every year. In addition, India buys Russian oil through traders in the UAE, which also involves local currency settlements to avoid potential sanctions.

In July 2023, following Indian Prime Minister Narendra Modi's visit to the UAE, the two countries agreed to establish a framework for local currency settlement of cross-border trade and develop a local currency settlement system as an alternative to the Society for Worldwide Interbank Financial Telecommunication (SWIFT) payment system. Subsequently, RBI allowed UAE banks to open special rupee accounts in Indian banks for trade settlement and encouraged importers and exporters to use rupees and dirhams for direct transactions. The month marked the first time India used the rupee for crude oil transactions with the UAE. However, reports indicate that such transactions have not been sustained.

According to India Today, local currency settlement could help develop the rupee-dirham foreign exchange market and provide new opportunities for India's financial sector. It may also set a precedent for bilateral local currency settlements with other countries, exploring the internationalisation of the rupee as well as reducing dependence on the US dollar. In addition, local currency-settled flows are more susceptible to monitoring by the RBI. Encouraged by RBI, some banks have already started promoting local currency settlement through measures such as discounted service charges, which has attracted some small and medium-sized traders to switch systems. However, larger firms with large amounts of capital lack incentives to convert, resulting in lower trading volumes.

**New Delhi Initiative**

In the recent past, India has taken a number of steps to promote the internationalisation of the rupee.2024 In May 2024, RBI's annual report mentioned that the central bank had allowed banks to open rupee accounts and provide rupee loans to non-resident Indians abroad. Going forward, RBI plans to further liberalise regulatory measures for non-resident rupee accounts to promote FDI and foreign portfolio investment.

RBI and the Central Bank of Russia have resumed talks to expand the local currency settlement mechanism aimed at solving payment problems arising from the surge in bilateral trade in recent years, the Russian newspaper Kommersant reported. Russian experts admit that the negotiations are challenging due to Western sanctions and pressure. Halina, an associate professor at Russia's Higher School of Economics, said the basic exchange rate mechanism agreed between RBI and the Central Bank of Russia facilitates transactions in non-dollar currencies, which will positively affect bilateral trade, help overcome sanctions hurdles and reduce dependence on the dollar. Sergey Sheresnenko, Head of the Department of International Economic Relations at the Russian Financial University, noted that both Russia and India understand that the settlement of such transactions must be free from the control and supervision of the US Treasury.

**"The rupee is not a hard currency" **

On the 18th, Lin Minwang, deputy director of the Centre for South Asian Studies at Fudan University, said in an interview with the Global Times that the RBI's requirement that countries with which India has trade surpluses use the rupee for settlements is aimed at promoting the internationalisation of the rupee. Last year, India asked a number of South Asian countries to use the rupee for payments, and the practice has now been extended to large trading partners such as the UAE and Russia, even though India has significant trade deficits with those countries. India's emphasis on local-currency settlements is largely driven by a desire to reduce its dependence on the dollar and its use, a shortage of dollar reserves that has caused difficulties for the Indian economy in the past.

However, The Hindu noted that India's efforts to promote local currency settlements face significant challenges. While the dirham has remained stable against the US dollar, the rupee has continued to depreciate, and there is a significant difference in the movement of interest rates between the two countries. Local currency settlement systems can be applied to short-term and small transactions, but the complexities that can arise in long-term and large-scale use are difficult to predict. In addition, given that the UAE remains in a trade surplus position, UAE banks will accumulate more Indian rupees if the two sides continue to settle in local currencies. The last currency swap agreement between the two countries was signed in 2018 for about $500 million, much smaller than their current trade deficit. To solve this problem, the UAE needs to be helped to find profitable investment avenues in India to absorb the rupees they receive.2023 In May 2023, Russian Foreign Minister Sergey Lavrov told a meeting of foreign ministers of the Shanghai Co-operation Organisation (SCO) that Russia had amassed billions of rupees in Indian banks, but that these funds could not be converted into other currencies or effectively used to buy goods. The Hindustan Times had previously reported that Russia was addressing this problem by investing in the Indian domestic market.