Razorpay Payment Gateway: In Focus: India's Local Currency Settlement Targeted to Reduce US Dollar Dependence

RBI imposes new rules on UAE payments

The Reserve Bank of India (RBI) has instructed banks that before making payments to the UAE, they need to obtain an equivalent amount of dirham funds from other banks, thereby bypassing the conversion of Indian rupees into US dollars and then into dirhams in the international foreign exchange market, Reuters reported. Reuters notes that the process is in its infancy and RBI has not yet set any mandatory targets. Instead, it continues to encourage the formation of a rupee-dirham foreign exchange market and has asked 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 products such as refined chemicals and electrical appliances. While the UAE has historically enjoyed a trade surplus with India, the outbreak of the Russia-UAE conflict in 2022 led to Russia replacing the UAE as India's main supplier of oil, narrowing the trade imbalance between the two countries.

However, the demand for direct currency settlements between India and the UAE remains high. The Times of India reports that a large number of Indian workers and professionals are employed in the UAE and send large remittances back to India every year. In addition, India buys Russian oil through traders in the UAE, involving local currency settlements to avoid potential sanctions.

In July 2023, after Indian Prime Minister Narendra Modi's visit to the UAE, the two countries agreed to set up a framework for local currency settlement of cross-border trade and develop a local currency settlement system as an alternative to the 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 traded crude oil with the UAE in rupees, although reports indicate that such transactions have not been ongoing.

Direct currency settlement between the two countries 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 possibility of internationalising the rupee and reducing dependence on the US dollar. In addition, the flow of funds settled in local currency is more easily monitored by the RBI. Encouraged by RBI, some banks have started promoting local currency settlement through measures such as lowering service charges, which has attracted some small and medium-sized traders to switch systems. However, large corporates with large amounts of capital lack incentives to switch, resulting in relatively low trading volumes.

India takes steps to set up new mechanism with Russia to bypass dollar

India has recently taken a number of steps to promote the internationalisation of the rupee.2024 In May, RBI's annual report mentioned that the bank has allowed banks to open non-resident rupee accounts and provide rupee loans to non-residents.RBI plans to further relax regulatory measures for non-resident rupee accounts in the future to promote FDI and foreign portfolio investment.

The Economic Times of India has reported that India and Russia are exploring the establishment of a benchmark exchange rate between the rupee and the rouble to facilitate direct trade using these currencies. The report also says that senior regulators and bankers in both countries are seeking to overcome dollar-based trade barriers imposed on Moscow by the West.

India's bilateral trade with Russia has surged in recent years, especially in the aftermath of the 2022 conflict in Ukraine, when the West imposed sanctions on Moscow. India has become the second largest buyer of Russian crude oil after China.

According to India's Ministry of External Affairs, India's imports of Russian goods have increased by about 83,001 TP3T since 2021 under the Strategic Crude Procurement policy, while India's exports to Russia have increased by 591 TP3T.

However, payments for oil and other large imports require the services of large Russian banks. The Economic Times quoted a bank official as saying that "a market and exchange rate for rupee-rupee transactions and a financial settlement system that could be an alternative to SWIFT" are crucial in this context. A senior banker told the publication that the reference rate of exchange of the rupee to the rouble could be set by the Reserve Bank of India and the Central Bank of Russia, with modification clauses to conform to the underlying market realities.

Bank officials will also discuss measures to increase the use of rupee balances in special accounts opened in Indian banks, the Economic Times added. The reason for the large presence of rupee balances is that Russian exports to India paid in rupees exceed Indian exports to Russia.

Bloomberg reports that Russia has accumulated billions of dollars worth of rupees in Indian banks.