Dirham-rupee trade deal: At the annual conference of the Reserve Bank of India in the first week of April, Prime Minister Narendra Modi urged stakeholders to elevate the rupee to the status of an international currency. Amid the fervour and anticipation surrounding the internationalisation of the rupee that had been building up for over a year, it has now materialised through a pioneering initiative with the UAE, involving the settlement of cross-border transactions in the local currency.
The implementation of the memorandum of understanding (MoU) signed between India and the UAE was achieved in less than a month, reflecting the enthusiasm and commitment of the leaders of both the countries to utilise local currencies (dirham and the rupee) for transactions, including in critical sectors such as oil and gold trade.
The enthusiasm and commitment to foster a digital ecosystem for settling trade in local currencies are further validated by the decision to establish an interface between India’s Unified Payments Interface (UPI) and the UAE’s Integrated Payment Platform (IPP). This agreement is historic as it not only sets the template for similar arrangements with other countries but is also commercially significant as it aims to facilitate an ecosystem for settling even private remittances of Indian professionals and workers, adopting a trickle-down approach. In this context, it is crucial to comprehend both the opportunities ahead and the challenges that need to be addressed to make this a reality.
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The integration of UPI with IPP marks a significant advancement in technological collaboration between the two nations. This endeavour not only facilitates smoother financial transactions but also raises critical questions about the security and privacy of the data exchanged. Ensuring robust cybersecurity measures is paramount, as the scope of these transactions will attract considerable attention from cyber threats. Both countries must invest in state-of-the-art security protocols to protect the integrity of the transactions and maintain the trust of their citizens and international partners. This technological leap could serve as a blueprint for future digital collaborations, potentially influencing global standards in fintech security.
This agreement effectively transforms the hype around the internationalisation of the rupee into reality. The UAE is India’s third-largest trade partner and the second-largest source of remittances. It is also the fourth largest supplier of oil and gas and ranks among the leading investors in India, particularly in infrastructure projects through its sovereign wealth funds. Most importantly, this sets an impressive template for similar arrangements with other countries for petroleum trade.
With the evolving geo-economic order cluttered with sanctions and financial embargoes, using the rupee as the currency for trade transactions can reduce exchange rate risk for India. As India heavily depends on oil and gas imports, it makes sense to conduct these trades in rupees as it can mitigate the impact of exchange rate fluctuations between the rupee and other major currencies, such as the dollar. This stability can positively impact India’s economy and contribute to a more predictable import bill.
Dirham-rupee trade
Moreover, petroleum trade in the rupee can also provide India with greater control over its monetary policy. As the rupee will be used for oil transactions, the country’s central bank can have a direct influence on managing currency supply, interest rates, and inflation. This control allows for better alignment of monetary policy with domestic economic objectives and simultaneously boosts the international standing of the rupee. AED-rupee trade can also contribute to India’s energy security by cutting significant exchange conversion costs, thus benefiting us commercially.
The socio-economic implications of establishing the AED-INR trade are profound. By reducing dependence on traditional hard currencies like the dollar, this initiative could alleviate some of the economic pressures on India’s foreign reserves. Additionally, it has the potential to enhance the economic resilience of Indian expatriates working in the UAE by simplifying remittances. Such a shift in trade and monetary transactions is likely to have a ripple effect on local economies, potentially leading to increased investment and job creation in sectors directly benefiting from reduced transaction costs and streamlined processes. It is crucial for policymakers to monitor these socio-economic changes closely to optimise benefits and mitigate any unintended consequences.
It is essential to engage in discussions not only with other major trade partners to forge similar arrangements. India must increase its commercial and diplomatic outreach with other countries and their central banks/financial institutions to gauge their interest, assess concerns, and explore similar partnerships. While celebrating this arrangement, it is high time to develop the necessary financial infrastructure to support the trade settlement in local currencies, i.e., facilitating banking systems, currency exchanges, and payment mechanisms. A detailed transition plan will help us reap the benefits of the AED-rupee payment system.
Amid the formalisation of such arrangements, we should be vigilant in identifying potential challenges, assessing strategies and counter-strategies on geo-economic and geo-political developments, analysing the risks involved in settling trade in local currencies, considering factors such as trade flows, currency stability, market dynamics, and most importantly, our international relations. The Financial Action Task Force’s decision to grey-list the UAE and its associated impact on the cost of financial and banking operations can be one such area of concern.
Focus on regulatory compliance
When settling trade in the rupee, several precautions can be taken to ensure smooth and secure transactions. It is high time to focus on regulatory compliances, not only of applicable regulations and guidelines set by the Reserve Bank of India but also of other relevant regulatory bodies like the Directorate General of Foreign Trade (DGFT), Enforcement Directorate, Customs, Directorate of Duty Drawbacks, and even data collection and dissemination agencies like DGCI&S.
Considering the Indian Rupee is not convertible on the capital account and there exists a restrictive system in place for foreign exchange regulation, it is vital to familiarise both the regulatory agencies as well as the business entities about the necessary documentation, reporting requirements, and restrictions related to conducting business in local currencies.
While drawing on previous international experiences, it is important to be aware of currency volatility risks, hence it demands the implementation of appropriate risk management strategies, especially for monitoring exchange rate fluctuations. Hedging options, such as currency forwards or options, should be employed to protect against adverse movements in the rupee exchange rate. For this arrangement to be actually operationalised, it is vital to draft a business manual which should address matters such as payment terms, delivery obligations, exchange compliances, dispute resolution mechanisms, and any other applicable laws.
Furthermore, there is a need for secure payment settlement mechanisms, and accordingly, we must explore associated business protocols for bank guarantees or letters of credit in addition to formalising electronic fund transfers via establishing an interface between India’s UPI and UAE’s IPP. This will ensure the timely and secure transfer of funds. Moreover, this agreement also demands the establishment of reliable currency conversion facilities to convert UAE’s dirham into rupee. Considering that the dirham is fixedly pegged with the dollar at 3.6725, it should not pose a significant challenge for us.
For India to foster an ecosystem for the settlement of trade in local currencies, it must nurture the depth in its financial markets, continuously increase our economic size and external engagements with robust regulatory compliances to enhance users’ confidence in the Rupee. The journey is indeed arduous, but the dirham-rupee trade deal sets the right stage for enhanced trade in local currencies.
(Ram Singh is Professor and Aaqib Chaudhary is Ph.D scholar at IIFT, New Delhi.)