The story so far: The Reserve Bank of India (RBI) on Monday issued a circular that detailed ‘additional arrangement’ for invoicing, payment, and settlement of exports and imports in Indian rupees. Under this mechanism, Indian importers could make payment in rupees to the Special Vostro account of the correspondent bank of the partner country, against invoices for the supply of goods or services from the overseas seller. Indian exporters shall be paid proceeds in rupees from the balances in the designated vostro account of the correspondent bank of the partner country.
How does this change the status quo?
Vostro accounts have been around for a while. They were likely not widely used because exporters in any country typically prefer settlements in a strong and stable currency.
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Also, there are at least three new aspects to the newly-issued circular, as G. Padmanabhan, former executive director at the RBI, points out. First, the RBI has explicitly said that exchange of messages in a safe, secure and efficient way may be agreed upon mutually between the banks of partner countries. Mr. Padmanabhan says, “I don’t think RBI has ever gone into the nuances of messaging standards in the past. The SWIFT system was seen as an acceptable standard for international transactions.”
It may be recalled that soon after Russia invaded Ukraine, the Belgium-based SWIFT, or Society for Worldwide Interbank Financial Telecommunication, a system that allows instant messaging among banks, began excluding Russian banks from transacting through this channel. The aim was to make it difficult and tedious for Russian entities to transact with the rest of the world. The RBI’s circular could be taken to mean that partnering banks may use any messaging system they deem fit and not confine themselves to the SWIFT platform.
Two, Mr. Padmanabhan points out, “RBI has allowed for surplus to be invested”. That is, the rupee surplus balance held in the vostro accounts may be used by the foreign entities for payments for projects and investments in India as also for investment in Indian government treasury bills and government securities.
Three, vostro accounts did not need permission earlier. Now the RBI has specified that banks acting as authorised dealers need to secure prior approval from the regulator to put in place this mechanism. This is likely because the RBI may seek to understand which countries are interested in this mechanism, and whether the accounts are being used for the purpose for which the RBI intended them to be.
Which countries may be interested in the facility?
The fresh enablement by the RBI seems intended to ease doing business with Russia. EEPC India Chairman Mahesh Desai says that ever since sanctions were imposed on Russia, trade has been virtually at a standstill with the country due to payment problems. With the new facility, “we see the payment issues with Russia easing,” he says.
Former banker and Associate Professor at SPJIMR Ananth Narayan says Russia may be the first country to show interest in using this facility. Russia enjoys a trade surplus with India and would be unlikely to prefer a currency such as the dollar or the euro in exchange for services at this point when it is facing sanctions from the West, he points out. “Opening a rupee account where Russia accumulates trade surpluses with India and using those to invest in Indian assets in India, may make sense to Russia. That country holds more than $600 billion in foreign currency and using $20-30 billion of that in rupee accounts may not be a challenge for them.”
How does the new mechanism help India?
For India, doing business with Russia using rupees would mean there is no hard currency outflow in such transactions, points out Mr. Narayan. The impact on the rupee market is that foreign currency outflow would be lesser by $3 billion every month. Technically, it would ease the downward pressure on the rupee, which has been sliding to fresh record lows frequently in the recent past.
However, the arrest in the rupee’s fall would be seen only in the medium to long term because in the current scenario, payments to Russia have anyway not been going through and a credit system has helped continuity of trade.
If other countries too begin showing interest in using the facility, then a strengthening impact may be seen more quickly for the rupee. Barclays MD and Chief India Economist Rahul Bajoria says, “Amid ongoing rupee weakness, the RBI’s steps appear to be aimed at reducing demand for foreign exchange... While incremental for now, we see these measures as useful long-term steps, which can enable greater use of the rupee in foreign trade.”
Which banks could choose to opt in?
Mr. Narayan says that larger banks may not immediately set up vostro accounts. If the sanctions by the West on Russia widen, such banks would not want to be caught in an environment where other parts of their international business get impacted. Smaller banks may be ideal for the purpose and could provide the service with a little bit of push by the Indian government, if need be.
