Latest RBI Circular: A Step towards Internationalisation of Rupee?

Background of the circular:

India has consistently taken measures to develop strong domestic financial markets. Previous measures are taken for stability:

  • Stronger fiscal & monetary policy

  • Inflation targeting framework

  • Lower volatility in the emerging market space

This circular is another addition to these measures bringing stability to the rupee by enabling bilateral trade in the domestic currency reducing reliance on the dollar in the long term.

Key highlights:

  1. Invoicing: Export and Imports can be denominated in INR

  2. AD banks have been permitted to open special Vostro accounts of the counterpart bank of the trading partner.

  3. Proceeds from Indian importers making payments in INR will be credited to the Vostro account of the trade partner’s bank

  4. Similarly, exporters will be paid from the balance of the designated Vostro account of the trading partner’s bank

  5. Balances of the special Vostro account can be used for payments of projects and investments, trade flow and investment in government T-bills, and government securities subject to provisions in FEMA

Understanding ‘Nostro’ and ‘Vostro’ accounts:

The difference between Nostro and Vostro is merely dependent on perspective. In Latin Nostro means ‘ours’ and Vostro means ‘yours’. To understand this better, let us take the case of two banks: SBI, Mumbai, and Chase Bank, New York.

SBI’s dollar-denominated account with Chase bank in New York will be known as a Nostro account from SBI’s perspective, while for Chase bank, it will be known as a Vostro account.

Even though raising invoices in INR was permitted earlier, there were no specific guidelines until now. Exporters could invoice and receive in INR as trade partners did not hold the rupee assets and opted for immediate conversion. The main challenge was from the point of view of importers. Importers could not make payments in INR as there was no way for their trade partners to hold these rupee assets without a Vostro account.

How does it work?

An importer can fix the exchange rate and make payment in INR to its trade partner. The proceeds will be credited to the Vostro account of the trade partner’s bank which can further be used to hold the INR for investments in G-Secs or managing trade flows.

Short-term impact:

We do not expect any short-term impact on the exchange rate as of now. The immediate impact would be on trade with countries like Russia and Sri Lanka. Trading with Russia in USD is difficult due to sanctions while Sri Lanka has scarce dollar reserves. However, the acceptability of the rupee as a medium of trade is important for such measures to bear fruit. The exchange rate risk is transferred from the domestic players to the trade partners who will bear the volatility of the rupee. The Rupee has depreciated around 3.5% to 4% p.a for the last 8 years which adds up to a challenge for the rupee asset holders.

Prepared By:

Swaraj Rajagopal

Analyst- Treasury Markets

Almus Risk Consulting LLP.

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