Introduction
India’s central bank, the Reserve Bank of India (RBI), is taking steps to encourage local banks to facilitate trade settlements between the United Arab Emirates (UAE) and India using the dirham (AED) or the Indian rupee (INR) instead of the U.S. dollar. This move is aligned with the RBI’s broader strategy of promoting settlement in local currencies with countries where India has a trade deficit. By reducing reliance on the U.S. dollar, India aims to enhance the global reach of the Indian rupee and address its trade imbalance with the UAE.
Shifting Away from Dollar-Based Transactions
India’s trade deficit with the UAE amounted to $21.62 billion in the fiscal year 2022/23, representing 8.2% of its total deficit, as per government data. To mitigate the outflow of dollars due to this trade deficit, the RBI has urged banks to facilitate trade settlements between India and the UAE using the Indian rupee or the UAE dirham. This initiative follows an agreement reached in July between the two countries to promote trade in rupees instead of dollars.
RBI’s Directive to Banks
A treasury official at a private bank revealed that the RBI has instructed banks to gradually encourage their clients and corporate entities to initiate INR-AED trades, moving away from dollar-based transactions. This directive was conveyed verbally by an RBI official during a seminar for foreign exchange dealers. While this communication has not been previously reported, its aim is to bolster the volumes of local currency trades.
Focus on Corporates and Large Clients
The RBI’s strategy involves initially focusing on large clients and corporate entities to promote INR-AED trades. The central bank recognizes that their stronger balance sheets make them better positioned to engage in non-dollar-denominated transactions. However, so far, larger corporates have displayed reluctance in participating in such deals that are not dollar-denominated.
Challenges and Incentives
Despite the RBI’s push, current cross-currency trade volumes between India and the UAE remain relatively low. This poses a challenge, particularly for smaller companies that may find it difficult to pay for their entire imports in dirhams. To address this, banks have been incentivizing smaller companies by offering discounted service charges to encourage them to embrace non-dollar-denominated transactions.
Conclusion
India’s RBI is taking a proactive stance in encouraging local banks and businesses to embrace trade settlements in local currencies, such as the Indian rupee and the UAE dirham. By shifting away from dollar-based transactions, India aims to reduce its trade deficit with the UAE and enhance the global role of the Indian rupee. This strategic move not only reflects the evolving dynamics of international trade but also underlines India’s commitment to fostering stronger economic ties with its trading partners.