Note4Students

From UPSC perspective, the following things are important :

Prelims level: Rupee Settlement System for International Trade

Mains level: Read the attached story

RBI has decided to put in place an additional arrangement of international trade for invoicing, payment, and settlement of exports / imports in INR.

Banks acting as authorised dealers for such transactions would have to take prior approval from the regulator to facilitate this.
All exports and imports under the invoicing arrangement may be denominated and invoiced in Rupee.
Exchange rate between the currencies of the two trading partner countries may be market determined.
Exporters and importers can now use a Special Vostro Account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees.
These accounts can be used for payments for projects and investments, import or export advance flow management, and investment in Treasury Bills subject to Foreign Exchange Management Act, 1999 (FEMA).
Also, the bank guarantee, setting-off export receivables, advance against exports, use of surplus balance, approval process, documentation, etc., related aspects would be covered under FEMA rules.

Nostro and Vostro Accounts

Nostro and vostro are terms used to describe the same bank account; the terms are used when one bank has another bank’s money on deposit.
They are used to differentiate between the two sets of accounting records kept by each bank.
Nostro comes from the Latin word for “ours,” as in “our money that is on deposit at your bank.”
Vostro means “yours,” as in “your money that is on deposit at our bank.”

Why such move?

The rupee is at a historic low against the dollar.
The mechanism is meant to facilitate trade with countries under sanction.
Payments had become a pain point for exporters immediately after the Russia-Ukraine war broke out, especially after Russia was cut off from the SWIFT payment gateway.
As a result of the trade facilitation mechanism, we see easing of payment issues with Russia.
The move would also reduce the risk of forex fluctuation specially looking at the Euro-rupee parity.
We see this as a first step towards 100% convertibility of rupee.
It will also help stabilize rupee.

What does the change mean for exports?

Several countries including Sri Lanka and some in Africa and Latin America are facing forex shortage.
As such, the new mechanism will help India promote its exports.
It will also help buy discounted crude oil from Russia, which now accounts for 10% of all imported crude.

Will the move help narrow trade deficit?

The gap between India’s exports and imports widened to record highs.
This puts pressure on the current account deficit, which some economists estimate would nearly double to more than 3% of GDP in FY23.
RBI’s decision may not benefit the external account immediately, but over the medium term, demand for dollars may come down.
This is partly because opening of new vostro accounts between banks may take some time.

Back2Basics: Currency Convertibility

Convertibility is the ease with which a country’s currency can be converted into gold or another currency through global exchanges.
It indicates the extent to which the regulations allow inflow and outflow of capital to and from the country.
Currencies that aren’t fully convertible, on the other hand, are generally difficult to convert into other currencies.
Having a convertible currency allows a government to pay for goods and services in a currency that may not be the buyer’s own.

Convertibility of Rupee

In order to face the serious current account deficit in the balance of payments, the Government of India introduced the partial convertibility of rupee from March 1, 1992.
This was an inevitable move for the expeditious integration of Indian economy with that of the world.
Under this system, 60 per cent of the exchange earnings were convertible in rupees at market-determined exchange rate and the remaining 40 per cent were at the officially determined exchange rate.
Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes.
Capital account convertibility refers to a similar liberalization of a country’s capital transactions such as loans and investment, both short term and long term.

A bit difficult, but pls take an effort to try this PYQ from CSP 2020:

If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?

Not depending on short-term foreign borrowings

Opening up to more foreign banks

Maintaining full capital account convertibility

Select the correct answer using the code given below:

(a) 1 only

(b) 1 and 2 only

(c) 2 only

(d) 1, 2 and 3

Post your answers here. Detailed explanation will be provided.
10
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