Why are Sri-Lanka and Russia considering Indian rupee for International Trade and not US dollar?

Indian rupees

Compiled by Preya Pandya

A major Economic Change is being observed around the globe. The Indian Rupee is entering a new era of global acceptance. India has been at the forefront of the major international events in 2022. From the Russia-Ukraine war to Sri Lanka’s bankruptcy, India has been in the spotlight. India has provided help and maintained relations with almost every major country recently. The Government of India and the Reserve Bank of India have been planning to internationalise the Indian Rupee for quite some time now. 

The State Bank of India’s Ecowrap report had recommended a conscious effort to ‘internationalise’ the rupee given the capital outflows from emerging market economies, including India, and currency depreciation. Thereafter, via a circular dated July 11, 2022, the central bank allowed the international settlement of trade in Indian Rupees for export and import of goods and services. 

What is Internationalisation? 

Internationalisation of the rupee is a process that involves increasing use of the local currency in cross-border transactions. 

What does it mean for India Rupee? 

  • It involves promoting the rupee for import and export trade and then other current account transactions followed by its use in capital account transactions. 
  • As far as the rupee is concerned, it was fully convertible in the current account, but partially in capital account. 
  • Current and Capital account are the two components of Balance of payments. While the current account deals mainly with the import and export of goods and services, the capital account is made up of the cross-border movement of capital by way of investments and loans. 

Why is the Need for Internationalisation of Rupee? 

  • The dollar accounts for 88.3% of global foreign exchange market turnover, followed by the euro, Japanese Yen and Pound Sterling; the rupee accounts for a mere 1.7%, underlining the need for pushing the currency much farther to get an international tag. 
  • In the case of the dollar, which is an international currency, the ‘exorbitant’ privileges include immunity from Balance of Payments crises as the USA can pay for its external deficits with its own currency. 

Advantages of Internationalisation of rupee:  

  • Use of Rupee in cross-border transactions mitigates currency risk for Indian business. Protection from currency volatility not only reduces cost of doing business, it also enables better growth of business, improving the chances for Indian business to grow globally. 
  • It reduces the need for holding foreign exchange reserves. While reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy. 
  • Reducing dependence on foreign currency makes India less vulnerable to external shocks. Reduced exposure to currency risk would substantially mitigate the pain of reversal of capital flows.  
  • As the use of Rupee becomes significant, the bargaining power of Indian business would improve adding weight to the Indian economy, enhancing India’s global stature and respect. 

How did India Internationalise the Rupee? 

The Indian government since 2022 July, has been looking to bring countries that are short of dollars, into its rupee settlement mechanism. Special rupee accounts for international transactions between designated countries are called Vostro accounts.  

The mechanism for international trade settlements in rupees at market-determined exchange rates means that Indian importers can now make payments in ‘rupee’ which will be credited to a Vostro account (special rupee accounts in Indian banks) of the corresponding bank of the partner country, while Indian exporters will be paid from the balances in the designated Vostro accounts. The surplus rupee balance in the Vostro accounts can be used for investments in government securities, payments for projects and investments, and for export-import advanced flow management. 

Now let’s understand why Sri Lanka and Russia were keen to take up the Indian Rupee for their trade 

The countries of Russia and Sri Lanka were presented with the perfect opportunity at the correct time by the opportunistic Indian Government.  

Why Sri Lanka is taking INR as a foreign currency and what it means? 

The country of Sri Lanka has been short on the US dollars for transactions after recent economic crisis. Designating INR as a legal currency in Sri Lanka will provide the country with much-needed liquidity support to help it tide over its economic crisis amid inadequate availability of the US dollar.  

With a foreign currency (in Sri Lanka’s case the INR), the country’s economy is more likely to prevent further intensification of the balance of payments crisis when the investors begin selling off in domestic currency.   

It means that Sri Lankan citizens can now hold $10,000 (INR 8,26,823) in physical form. This also means that Sri Lankans and Indians can use Indian rupees instead of US dollars for international transactions with each other. 5 Vostro accounts for trade in Sri Lanka have been opened.  

Why Russia Decided to do the same?  

We have all read about the Russia-Ukraine war. The implications of declaring war on ukraine were severe for the Russian Economy. The US and Europe to cut off Russia from the global financial messaging system known as SWIFT. The action, described as a “financial nuclear weapon” by the French, left most major Russian banks estranged from a network that facilitates tens of millions of transactions every day, forcing them to lean on their own, much smaller version instead. 

Hence Russia also set up 12 Vostro Accounts for rupee transactions. 

After understanding this, you might be wondering, ‘Why not the US dollar?’ 

While the reason for Russia is obvious, to understand the reason for not considering the US dollar for Sri Lanka as well as for other nations is not.  

To understand this, we have to consider other factors- 

  1. The US dollar was used as a financial weapon to levy sanctions on Russia. This was seen by the entire globe as a big concern as this gave too much power to a single nation. The fact that a single nation could use their currency to have such a huge financial impact on a country simply by cutting it off from using its currency for trade shocked nations.  
  1. The dollar has strengthened about 7% in 2022, on track for its biggest annual advance since 2015, according to a Bloomberg index of the dollar. The gauge reached a record high in September 2022 as dollar appreciation sent everything from the British pound to the Indian rupee to historic lows. 

The sheer strength of the dollar, its use under President Joe Biden to enforce sanctions on Russia this year and new technological innovations are together encouraging nations to start exploring other options.  

India took complete advantage of this opportunity. So far, India’s central bank has given approval to banks to open 12 Vostro accounts for trade in rupees with Russia. Six other accounts, including five for trade with Sri Lanka and one for trade with Mauritius, have also been authorised, a Reserve Bank of India document cited by Economic Times showed. Countries such as Tajikistan, Cuba, Luxembourg and Sudan, too, reportedly are in talks about using the rupee settlement mechanism