As India and Russia discuss FTA, the elephant in the room is rupee trade

Finding alternative paths to buy oil from states under Western sanctions is stretching the government and RBI's creativity

Even as India and Russia discuss a free trade agreement to deepen bilateral ties, the elephant in the room is the rupee trade. This is an issue to which not just Moscow but Iran, the other partner under Western sanctions, is also seeking answers.

In the context of the new trade architecture developing in the world to bypass the US dollar, bankers and traders with whom this correspondent spoke said the most difficult aspect of taking bilateral trade out of the multilateral system of mostly dollar-denominated trade is that the rules change with each country. “Sanctions are not the problem as much as how countries are unwilling to give up their advantage,” said one trader who deals with both Iran and Russia. New Delhi has limited rupee trade with some countries but these are small and preliminary deals with countries with which India runs trade surpluses.

For instance, forex-strapped Iran has agreed to treat the Indian rupee as a reserve currency, said one of the bankers involved in the bilateral trade transactions between the two countries. But Russia, now India’s largest crude oil supplier, is unwilling to play ball because its forex reserves have vastly expanded.

Russia has offered to use the Chinese yuan as a reserve currency but this is not acceptable to India. Pending the settlement, some of the payments for the Russian crude have been deferred, but this is only a hiatus. The real problems will begin when the EU price cap of $65 a barrel on Russian oil is breached, as it is bound to do soon after the OPEC Plus decision to cut production. The Ministry of External Affairs has reached out to the RBI with the same demand Indian traders have made — be a bit more creative in how rupee is traded overseas.

The Iranian agreement has helped in a number of ways, including paying the salaries of those employed at the Chabahar Port. This has also eased the terms for trade between the Indian rupee and the Iranian rial. Since Moscow does not consider the rupee a reserve currency, it makes the rules that govern India-Iran banking relationship difficult to extend there. This means when an Indian trader wishes to pay his counter-party in rupees for an export to Russia, there are no fixed rules on how to go about it.

What happens when, say, MRPL, a subsidiary of state-owned oil refiner IOC, the largest importer of Iranian crude, wishes to pay for the consignment in Indian rupees? “We have to think out of the box,” said a banker. The US has no problem if MRPL pays for the consignment in dollars through designated US banks because this means the US Treasury, which monitors the sanctions, can keep tabs on how much crude is being sold. So trade volumes are necessarily limited.

For the rupee payment route, MRPL has to open an account with a designated Indian bank, usually UCO Bank, headquartered in Kolkata. That works because UCO Bank has no dealings with the US. Likewise, the exporter of crude, an Iranian company, also opens an account with an Indian bank (potential problems lie in the fact that MRPL also operates through Bank of Baroda, which has US operations).

The rupee payment from the Indian importer is transferred to the account of the Iranian oil company, which then transfers the sum to itself in Iran. It becomes an asset of the oil company against which an Iranian bank will purchase rupees from the oil company and give it Iranian rials. The rate depends on the underlying exchange rate between the two currencies, unsurprisingly denominated in US dollars.

Then the Iranian bank buys rials from the Central Bank of Iran paying for it with the Indian rupee. The rupee now enters the Iranian central bank’s balance sheet. This is held by the central bank, partly as reserve and partly to pay for the demand from other Iranian companies for rupees to pay for their imports, such as tea, rice and basic engineering goods.

Since there is always a vast unmet demand within Iran for forex, the central bank is willing to hold some Indian rupee as reserves, too. But even then it runs a limit on how much rupee it will hold. Indian exporters to Iran have to operate within an annual limit of less than $1 billion. For the past few years, New Delhi has been pushing Tehran to increase this limit.

However, the same banker said, as the volume of trade with Iran has risen, the reserves held as Indian rupee have declined due to rising demands from traders, especially now that Iran’s trade surplus with India is narrowing since New Delhi is buying more oil from Russia.

Besides, a via media has opened up through the UAE. Several Iranian importers invoice their trade in dirhams to buy from India. The Indian traders get their payments for the consignments in Indian rupee from the UAE.

But for Russia, the rupee is hardly tradable except to exchange with India, so it doesn’t make sense for the Bank of Russia to hold any reserves. A reserve currency should be valid for trading between say, Russia and Indonesia, yet payable in Indian rupees. A non-resident account in an Indian bank that either Iran or Russia operates allows only for buying of Indian goods. Given that India runs a massive trade deficit with Russia, it is difficult to see what goods India can offer Russia.

The demand from Russia is the trigger that has made the RBI enthusiastically support the internationalisation of the rupee. However, there are concerns here, too. “Our concern is that a Russian invoice for a good may often be a cover for import of something else,” said an RBI official. He is referring to weaponry or other goods proscribed by the G7.

Indian banks have also argued for alternatives, such as allowing a rupee-denominated loan to Russia, similar to the $4 billion line of credit that India has offered to Sri Lanka. But a loan to Russia will have to be commensurately larger and in any case can come through only when the war ends.

Of late, Moscow has become more willing to discuss options with New Delhi, after the G7-led cap on the price of its crude has begun to bite. Till prices were below the cap, trade was being settled in mostly UAE dirham. But with the OPEC Plus production cuts pushing up prices, the caps on the Russian grades have become irrelevant. But the UAE central bank has indicated to India it will not allow commercial banks there to breach the cap since they could fall foul of the sanctions. Recognising the problem, Finance Minister Nirmala Sitharaman said on the sidelines of the IMF-World Bank meeting, “We will have to constantly refigure where we get the best deal as it is a critical input for the economy.” This will require fresh creativity.

The internationalisation of the rupee

·         India’s push for rupee invoicing in international trade got momentum in Foreign Trade Policy (FTP) 2023, which proposes invoicing, payment and settlement of trade in Indian rupees

·         Rupee currently accounts for a mere 2% of global currency market turnover

·         Countries considering rupee trade include Russia, Saudi Arabia, Nigeria, UAE and Sri Lanka

·         The first country to open a special Rupee Vostro account is Russia followed by Sri Lanka and Mauritius

·         Effectiveness of rupee invoiced trade depends on India’s net trade deficit/surplus plus extent of trading in rupees in comparison to the total bilateral trade

·         There is a need to reduce capital account controls and reduce inflation

·         It also requires a steady rate of low import duties and flexibility in banking rules for NRI; a possible start by promoting rupee loans