PayU Payment Gateway: India's Rupee Settlement Order: What's in the Bag?

The Indian rupee: the dawn of a new era in trade settlement

Recently, the Reserve Bank of India (RBI) introduced a new mechanism for settling international trade using the rupee.

This mechanism allows Indian traders to open special accounts with banks in selected trading partner countries to enable all export and import transactions to be settled in rupees and invoiced in the same currency. The exchange rate of the rupee used by both parties is determined by the international offshore market rate, which has been declared with immediate effect.

The move follows Russia's announcement earlier this year that it would require the use of the ruble for gas transactions with unfriendly countries, marking the second major economy after Russia to implement a local currency settlement mechanism.

This decision has attracted widespread attention in the international community and has triggered a debate. Some saw it as a challenge to the "dollar's hegemony", while others were sceptical.

What is the strategy behind India's official announcement of 'rupee settlement' and what are they aiming to achieve?

"First aid" in economic crises

In recent years, as part of the so-called "Modiomics", the Indian government has aggressively pursued a "Digital India" strategy that includes building a Unified Payments Interface (UPI) and abolishing large-denomination currencies. giants such as Facebook, Google, SoftBank and Visa have invested heavily in the Indian payments industry, with platforms such as PhonePe and Paytm receiving significant international funding, Giants such as Facebook, Google, SoftBank and Visa have invested heavily in the Indian payments industry, and platforms such as PhonePe and Paytm have received significant international funding.

To some extent, the Indian government's actions in the area of payment clearing coincide with the country's desire to become a "major global player".

However, the seemingly radical Rupee Clearing Facility introduced by the Modi government is actually a move made under difficult circumstances.

Firstly, this action was in response to the requirement for non-US dollar settlements for trade with Russia and Sri Lanka. India's trade with Russia could not be properly collected due to Western sanctions prohibiting Russian financial institutions from using the SWIFT system and US dollar settlement channels. During Russian Foreign Minister Sergey Lavrov's visit to India in April, he proposed the use of alternative mechanisms for bilateral trade settlement. In addition, Sri Lanka's recent sovereign debt crisis has made India eager to seek non-dollar settlement methods.

Secondly, the international prices of energy, coal and commodities have soared due to the Russia-Ukraine conflict, leading to a deterioration in India's balance of payments position. According to India's trade ministry data, India's trade deficit widened to a record $2,563 million in June 2022, compared to $961 million in the same month last year. India's domestic inflation also remained above 71 TP3T for several months, exceeding the RBI's inflation tolerance rate of 61 TP3T.

Meanwhile, in the first half of 2022, India experienced a net outflow of nearly $30bn, the highest recorded withdrawal of foreign capital from the country during the period.The rise in the yield on 10-year government bonds from 6.46% at the start of the year to 7.39% in July has exerted significant depreciation pressure on the rupee.

Despite RBI's two recent adjustments in the market repo rate and direct intervention in the forex market, it could not change the weak performance of the rupee, which has cumulatively declined by 7% this year.This has led to a sharp decline in foreign exchange reserves from an all-time high of US$642.5 million in September 2021 to US$588.3 million in July 2022, the lowest point in the last 14 months.

Therefore, India introduced the "rupee settlement order" is mainly to avoid the rupee exchange rate crisis "first aid" measures, seeking short-term "save a little is a little" effect.

Symbolism may outweigh actual impact

Typically, the settlement of cross-border payments between banks involves two stages: information transmission and funds settlement. The current dollar-centred cross-border payment system is based on the technological and market dominance of the information transmission agency (SWIFT) and the funds settlement system (CHIPS). This makes the United States dollar the equivalent of various national currencies and creates network effects and payment inertia in the cross-border payment settlement system.

While the introduction of "rupee clearing" by the Government of India provides a payment settlement channel for local currencies circulating across borders and raises awareness and visibility of the country's monetary sovereignty, the choice of settlement currency is usually the result of market negotiations between the parties to a cross-border transaction. Even if India introduces a rupee settlement channel, its practical significance may not be significant if it is not recognised or used sufficiently in international markets.

For example, recently, India's largest cement manufacturer, UltraTech Group, purchased 157,000 tonnes of coal from Russia's Siberian Coal and Energy Company, paying in Chinese yuan, not rupees.

In addition, the internationalisation of the currencies of emerging market countries involves a combination of factors such as the depth and openness of domestic financial markets and the systemic integrity of financial mechanisms. Even the internationalisation of local currency settlements in developed economies, such as the euro and the yen, requires a long and tortuous process of market evolution and cannot be achieved overnight.

Considering India's share in international trade, the commodity structure of exports and imports and the elasticity of demand for trade in services, the symbolic significance of the rupee settlement mechanism may outweigh its practical impact, and its effectiveness needs to be further observed.

"The Indo-Pacific Economic Framework faces a major "embarrassment".

Currently, the most widely circulated currency in international trade is the United States dollar. Therefore, some consider India's initiative to be aimed at countering the "dollar hegemony".

This may be an exaggeration. However, from another perspective, the "rupee clearing mechanism" also reflects the urgent need to address the currency circulation problems caused by the "dollar hegemony".

In a global monetary system dominated by the United States dollar, United States Treasuries have become a safe asset globally, fuelling market demand for United States debt. The low interest rates on United States Treasuries effectively collect a "mint tax" from countries that use the United States dollar in their transactions, leading to an oversupply of international dollars. When international tensions escalate or the Fed tightens its balance sheet, it may trigger a new round of dollar liquidity crisis, leading to currency depreciation and inflationary pressures, forming a post-Bretton Woods "new Triffin dilemma" - the dollar assets as a safe-haven The "new Triffin dilemma" under the post-Bretton Woods system - a contradiction between the demand for dollar assets as a safe-haven and the decline in real United States bond interest rates.

Therefore, India's "rupee settlement order" can also be regarded as the inevitable response of emerging market countries to the problem of "dollar hegemony". Just last month, India is also regarded as the United States of America's "quasi-allies", its promotion of non-dollar payment action may be regarded as some of the speculation on U.S.-India relations politicians "face", to the United States of America's newly established "Indo-Pacific economic framework" to bring considerable "embarrassment". "brought considerable" embarrassment "to the United States of America's newly established" Indo-Pacific economic framework.

Indeed, this reflects the apparent harmony between the Governments of India and the United States in their cooperation. When there are common interests, they flatter each other, but when faced with divergent interests, they can "flip-flop faster than a book".

In recent years, challenges to the position of the United States dollar in payments and settlements have "blossomed". From the barter settlement mechanism established by Iran and the European Union to the construction of Russia's own messaging system, and from the use of private cryptocurrencies for cross-border payments to the accelerated development of official digital currencies (CBDCs) in various countries, these developments reflect a strong international demand for reform of the current supply of cross-border payment services.

It is expected that the "currency wars" between the major economies will intensify in the future, and the construction of a multipolar, competitive and inclusive international monetary system will become a common demand of the vast majority of developing countries.

Zhao Liang (PhD in Finance, Chinese Academy of Social Sciences)

Editor: Ke Rui

Proofreader: Liu Yue