UAE accepts "First" payment in Indian Rupees

UAE accepts "First" payment in Indian Rupees

GS-3: Indian Economy

(UPSC/State PSC)

Why in news:

Recently, UAE based Abu Dhabi National Oil Company (ADNOC) has approved the payment for one million barrels of crude oil purchased by Indian Oil Corporation (IOC) in Indian Rupees for the first time.

  • This is being seen as an important step towards the internationalization of the Indian rupee.
  • India had signed an agreement with the UAE in July 2023 to make commercial payments in Indian rupees.

Circulation of Indian currency in Gulf region:

  • In the 1950s, the Indian rupee was the legal tender for almost all transactions in the United Arab Emirates (UAE), Kuwait, Bahrain, Oman and Qatar, with the Gulf monarchies buying rupees with pounds sterling.
  • In 1959, to reduce the challenges associated with gold smuggling, the Reserve Bank of India (Amendment) Act was enacted, which enabled the creation of the "Gulf Rupee", notes issued by the central bank for circulation only in the West Asian region.
  • Indian currency holders were given six weeks to exchange their Indian currency, so that the conversion could happen smoothly.

About Internationalization of Rupee:

  • It is a process that involves increasing the use of rupee in cross-border transactions between residents and non-residents of India.
  • It includes the following activities to promote the rupee:
  • import and export trade
  • Current account transactions
  • Capital account transactions

India benefits from internationalization of rupee:

  • Reduction in import bill: 85% of India's oil needs are met by imports.
  • Less dependence on the dollar: The dollar accounts for 88.3% of global foreign exchange market turnover, followed by the euro, Japanese yen and pound sterling; The value of the rupee is only 1.7%.
  • Savings on foreign exchange transactions for Indian residents.
  • Reduction in foreign exchange risk for Indian corporations.
  • Reduction in dependence on foreign exchange reserves for stability of balance of payments.
  • Appreciation of currency value.
  • Mitigation of exchange rate volatility.
  • Lower cost of capital due to better access to international financial markets.
  • The ability to avoid payment disruptions caused by events such as the Russia-Ukraine war will increase.

Challenges faced by India in internationalization of Rupee:

  • Weakening of international demand: The daily average share of the rupee in the global foreign exchange market is about 1.6%, while India's share in global goods trade is about 2%.
  • Parliamentary Standing Committee report said there were few buyers for the Indian rupee.
  • During FY 2022-23, no crude oil imports by oil PSUs were settled in Indian Rupees.
  • Not allowing full capital account convertibility in India: This is driven by the previous fear of capital flight (capital outflow from India due to lack of monetary policies/growth) and exchange rate volatility given the significant current and capital account deficits.

Implications of Internationalization of Currency:

  • Internationalization of a currency may increase external risk, given the open channels of flow of funds in and out of the country and from one currency to another.
  • Providing greater liquidity needed by the growing world economy will require India to run a persistent current account deficit, making it increasingly indebted over time.
  • This may lead to a conflict of interest between short-term domestic and long-term international economic objectives.

India's efforts for internationalization of rupee:

  • To boost the role of the rupee in cross-border payments, the Reserve Bank of India in March 2023 allowed more than a dozen banks to settle trade in the rupee with 18 countries.
  • Banks of these countries have been allowed to open Special Vostro Rupee Accounts (SVRA) for settlement of payments in Indian Rupee.
  • In July 2022 RBI issued a circular on “International Trade Settlement in Indian Rupees”.
  • RBI enabled external commercial borrowings (especially masala bonds) in rupees.

India's three-pronged strategy:

  • Purchasing from the cheapest available source, diversifying sources of supply and not violating any international obligations such as price caps in the case of Russian oil.

Way forward:

  • To ensure free convertibility of the rupee with the target of full convertibility by 2060.
  • To provide additional rupee investment options to foreign investors and Indian trading partners, the RBI should work to create a more extensive and liquid rupee bond market.
  • Indian importers and exporters should be encouraged to issue rupee invoices for their transactions.
  • The currency swap agreement will help India settle trade and investment transactions.
  • Tax incentives for foreign businesses to use rupee in operations in India will also help.
  • The recommendations of the Tarapore Committees (in 1997 and 2006) should be implemented:
  • Emphasis on reducing fiscal deficit below 3.5%,
  • Reduction in overall inflation rate to 3%-5%, and
  • Reduction in gross banking non-performing assets to less than 5%.

Source: The Hindu

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Mains Question:

Outline India's major initiatives related to rupee internationalization and consider its benefits and challenges.