Indian rupee is falling aggressively compared to US Dollars. In 1995, one dollar was valued approximately 30 Indian rupees. In 2008 it used to trade around 40. Now in 2022, the value of one dollar is 80 rupees! If you look back through the history, from 2003, value of Sri Lankan rupee was depreciating significantly compared to US dollars. Are we getting dragged into the same path? Indian foreign exchange reserve fell roughly around 5 billion dollars in the last week of June from 593 billion dollars to somewhere between 586 to 588 billion dollars.
In case of Sri Lanka also, the foreign exchange reserve fell quite aggressively! If Sri Lanka could go back in time, what would they do? Their exchange reserves declined from 7.5 billion dollars to 15 million dollars. Imagine that fall!
So again, are we going to be another Srilanka? I will say NO.
Is this the time to panic?
Because, according to the reserve bank and government reports, India has 10 months of working capital left in the foreign reserve. That means India can meet their expenses for the next 10 months with the foreign reserve which we holds. But one thing to keep in mind is foreign institutional investors are withdrawing money out of India (pay close attention to the fact that the rate of withdrawal is low as of now).
In future if the war and inflation get worse, our foreign reserve can get depleted much fast and FII (Foreign Institutional Investors) can withdraw money from India.
But we cannot sit there and let that catastrophe bring our economy down. So RBI (Reserve Bank of India) have introduced Rupee settlement system. With this Article, I intend to make you aware of the Rupee settlement system and their primary objectives.
Indian Rupee Settlement System
Price of INR (Rupees) actually depends on supply of INR and demand of INR. Where this curve meets represents the price of INR. Look at the picture given below so that you will get an exact idea of what that means. Now, in current economic conditions occurred due to COVID-19 pandemic as well as Russia-Ukraine war, INR has less demand compared to its supply. What we need to figure out now is how to increase the demand. It is obvious to think that why can’t we increase the supply side of the curve? It is another vast topic to discuss. But in short – we cannot print INR more than a certain limit since it makes Indian rupees inflated.
Rupee settlement system means all foreign countries who are trading with India should pay in Indian rupees. Right now, if they are paying with US dollars since it is considered as the global reserve currency. Countries like China and Russia are likely to accept this since they would want to trade with India in INR rather than US dollars.
How it actually works?
- Foreign Countries should express interest in adopting the system.
- Nostro and Vostro account should be open for the smooth functioning of Rupee settlement system.
- Russian banks will open account in India (Vostro) and Indian banks will open account in Russia (Nostro).
- Then the imports and exports can be paid in the nation’s currency itself hence replacing us dollars.
Advantages of Rupee settlement system
- This will help to prevent fall of INR.
- We will become less dependent on us.
- After implementing this system we will be using INR for exports and Imports. So demand of INR will increase.
- Decoupling from US dollar will be a resilient move in time of inflation.
- Help to keep foreign reserves from drying out.
Challenges to implement Rupee settlement system
- Majority of the trade happening around the world is happening in US dollars, Japanese Yen or Euros. So it is less likely for another system to come forward and dominate the market at least for a short period of time.
- It will be only successful if this is accepted by the foreign countries who are doing trades with us.
- Rupee is not considered as the safe heaven or they don’t have a global currency status. So we have to see, which all countries are interested in this.
Does all this make sense?
Could this move globalize Indian rupee? Indian Rupee need to achieve that status in future where every country treat rupee as a hard currency which is widely acceptable. So we are making a step forward for the future. It cannot bring us any huge positive impacts in near future other than slight decoupling from US Dollar, hence preventing the fall of rupee. But in the long term this might be a major step to make emerging India one of the dominant force in global economy. Let’s see what the future holds! Hope for the best.