Eye on Emirati flows – first step for the internationalisation of the rupee | 18 July 2023 | UPSC Daily Editorial Analysis

July, 2023 UPSC
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What's the article about?

  • It talks about the agreement signed between the Reserve Bank of India (RBI) and the Central Bank of the UAE to establish a framework for enabling the use of the two countries’ local currencies for cross-border transactions.

Relevance:

  • GS3: Effects of Liberalization on the Economy, Changes in Industrial Policy and their Effects on Industrial Growth;
  • Prelims

Context:

  • The Reserve Bank of India (RBI) and the Central Bank of the UAE signed an agreement on July 15 to establish a local currency settlement system to promote the use of the Indian rupee and the UAE dirham bilaterally.
  • The new arrangement will allow exporters and importers to invoice and settle payments in their domestic currencies, which will help reduce the cost of currency conversion and facilitate cross-border transactions.
  • Signing of this agreement is considered as the first step in the internalisation of the Rupee by the experts.

Internationalization of the Rupee:

  • The internationalization of the rupee refers to the process of increasing the use of the Indian currency, the rupee, in cross-border transactions.
  • This process aims to promote the rupee as a widely accepted currency for international trade and cross-border payments.
  • Benefits of Internationalization:
    • Smoother International Trade: Internationalization of the rupee allows parties to transact directly in rupees, eliminating the need for currency conversions. This can simplify cross-border trade and reduce transaction costs.
    • Increased Efficiency: By using the rupee for international transactions, businesses can avoid the risks and costs associated with currency fluctuations and exchange rate conversions.
    • Boost to Indian Economy: Internationalization of the rupee can enhance the status of the Indian economy and increase its influence in global financial markets.
    • Reduced Dependence on Foreign Currencies: By promoting the use of the rupee in international transactions, India can reduce its reliance on foreign currencies and strengthen its economic independence.
  • Internationalisation Approach:
    • Increased Cross-Border Transactions: Internationalization involves encouraging and facilitating more cross-border transactions involving the rupee.
    • Capital Account Convertibility: Internationalization of the rupee often involves adopting full capital account convertibility, which allows for the free movement of capital between countries.
    • Promoting Acceptance: Efforts are made to promote the acceptance of the rupee as a means of payment in international trade and cross-border transactions.
  • It is important to note that the internationalization of the rupee is an ongoing process and its extent and impact can vary over time.
  • The successful internationalization of a currency requires various factors such as economic stability, market confidence, and regulatory frameworks that support cross-border transactions in the local currency.

Analysis:

  • The aim is to promote the use of the local currencies bilaterally, reducing dependence on a third country's currency, such as the U.S. dollar, for settling transactions.
  • The agreement covers current account payments, including those involving exporters and importers from both countries, as well as certain permitted capital account transactions.
  • To facilitate settlement, the two central banks will establish a Local Currency Settlement System and potentially interlink their payments messaging systems in the future.
  • The establishment of the settlement mechanism would lead to the development of a rupee-dirham foreign exchange market, allowing the two currencies to be priced independently of other currencies like the dollar and the euro.
  • This system would benefit Indian and Emirati businesses by eliminating exchange rate risks when quoting prices for goods and services, improving ease of doing business and boosting trade.
  • The India-UAE local currency settlement system could serve as a precursor for other bilateral currency agreements and potentially contribute to the internationalization of the rupee.
  • The success of the system will depend on the extent of adoption by businesses in both countries.
  • Emirati businesses need remunerative avenues to deploy potential rupee flows if they choose to receive payments in the Indian currency.
  • One possibility is increased investment by UAE-based firms, while another is the UAE serving as a currency entrepôt, enabling Indian businesses to use the dirham as a gateway for transactions with other countries.
  • Policymakers must be aware of the risks associated with such moves while also considering the opportunities presented by reestablishing currency ties.

Way forward:

While the India-UAE local currency settlement system presents opportunities for promoting the use of local currencies and reducing dependence on third-country currencies, policymakers must be aware of the potential risks associated with the system.



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