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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.
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Internationalization of the Rupee:
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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.
