Rupee-Dirham Deal: A New Era in India-UAE Trade Relations

Dr. Nilay Ranjan Singh

India and the UAE have long enjoyed a close and robust trade relationship. Indian expatriates in the UAE contribute significantly to its economy and play a major role in boosting India’s economy through remittances, forming one of the largest remitting diasporas. The two nations’ ties span cultural and economic spheres and have grown stronger in recent years. The UAE’s first-ever Comprehensive Economic Partnership Agreement (CEPA) was signed with India, highlighting the importance of their trade relations. Another milestone came last year when both countries agreed to conduct bilateral trade in their local currencies, leading to the creation of the rupee-dirham settlement mechanism.

What is the UAE Rupee agreement- INR/AED deal?

In July 2023, India and UAE formalized an agreement to settle transactions between the two countries in the respective currencies of Rupee and Dirham. This direct trade in local currencies was not only aimed at expanding bilateral trade to $100 billion under their free trade pact (CEPA) but also meant to develop a mechanism and ecosystem of directly dealing in two currencies as a natural progression just like some of the important currencies in the world, e.g. USD, Euro, etc. The ultimate aim is to develop a market wherein direct bidding can be done in two currencies, i.e., the INR/AED quote could be provided as is being done till now for INR/USD. AED being pegged with USD, theoretically, it doesn’t need a quote for AED/USD like INR/USD. Though the agreement was signed in July 2023, it was contemplated since the latter half of 2022.

Initially, it was presumed that India and the UAE might start by settling only about a quarter of bilateral trade in local currencies, covering the non-oil trade with a few banks on each side and scaling it further. It was presumed to cover around 20-25% of trade in local currency initially. The trade deficit in non-oil trade between India being less compared to the oil trade was one factor to consider. However, the first deal that happened in INR-AED was an oil deal. This gives us reason to ponder that the plan and execution don’t always go as envisaged and also gives us a reason to understand the impediments in making this deal successful. India has a trade deficit with the UAE from 2019-20, as India buys now more oil from here. Indian crude oil imports represent a significant amount and deplete foreign exchange. India is the world’s third-largest commodity importer, and payments for oil imports happen majorly in the US dollar, which fluctuates a lot, especially in recent years, when it has appreciated against most currencies.

Mechanism

The transaction mechanism is simple, wherein the exporter from UAE is expected to get payment in INR for the export made to India, credited to its account maintained with a bank operating in India (as permitted by the central bank) through the Special Vostro Rupee Account (SVRA) of their banker in UAE. The Vostro account means ‘your account with us’ i.e., UAE banks in INR in India are Vostro accounts. However, since this account is being opened for a special purpose, it is called a ‘Special Rupee Vostro Account’.

Similarly, Indian exporters are expected to receive the export proceeds in AED in their Dirham account opened by a UAE bank.

Thus, the invoices will have to be in the respective local currencies. For example, exports to India will be invoiced in INR, and exports to the UAE in AED.

  • Indian exporter ——— export to UAE ——- invoice in AED ———- payment in AED —-AED credited in a bank account in UAE
  • UAE exporter ——— export to India ——- invoice in INR ———- payment in INR ——— INR credited in a bank account in India

Progress
The first deal involved the Indian Oil Corporation (IOC) making payments in Indian rupees to purchase one million barrels of crude oil from Abu Dhabi National Oil Company (ADNOC). As reported in the media, some Russian oil imports have also been settled in rupees (Reuters). There have also been some deals in Gold, jewellery, the food sector, and mobile purchases from India. Still, very little data is in the public domain to ascertain the level of trade settled in bilateral currencies.

One important factor, though, has been the lack of active private sector participation, which restricts its appeal in popularising the Rupee-Dirham settlement. However, it is expected to pick up in 2024-25.

Perspectives
RBI is optimistic about the enhancement of settlements happening in rupees, reducing dependence upon the dollar. It has nudged the local banks to ask their clients to settle trade between the UAE and India using the dirham (AED) or Indian rupee (INR) to reduce U.S.-dollar-based transactions. It is generally believed that traders in India currently pay an average of 2% in transaction costs when they export to the UAE. Though CEPA has resolved the area of tax and duties, the transaction cost, foreign currency, and exchange cost are still one hurdle that affects Indian exporters (UAE exporters, too), especially small and medium exporters. Directly dealing with local currencies will reduce transaction costs substantially. This will also remove the requirement for foreign currency, mainly the dollar.

One very important factor that the Rupee-Dirham deal could bring is making Indian exports to the UAE more competitive and could boost Indian exports overall as the UAE dirham is pegged to the US dollar, making the rupee likely to appreciate against the dirham in the short term.

The new payment mechanism of INR/AED is an additional option to the current payment alternatives. In addition to lowering transaction costs, greater price transparency and quick settlement time are among the major benefits of this new settlement mechanism.

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Another factor is that this can help the UAE in its food security target and make it a manufacturing hub wherein Indian companies could set up shop here and target the GCC market. Small and medium enterprises could benefit the most, another aim of the UAE- to develop the MSME sector. However, the Rupee-Dirham aims to start the deals with larger corporates first and after stabilisation, take it to the smaller businesses because the small business will have problems in comprehending the whole process easily initially.

The major factors governing this arrangement are:

➣ As assessed, the Reserve Bank of India aims to encourage the INR-AED settlement for promoting settlement in local currencies with countries wherein India is running a trade deficit, ultimately boosting the rupee’s global reach and influence. India’s trade deficit with the UAE was $21.62 billion in 2022-23, 8.2% of its total deficit. India is the UAE’s second largest and the UAE is India’s third-largest trading partner. Bilateral trade between the two countries increased by 16 % to $84.5 billion in the Financial Year 2022-23 ($72.9 billion in FY2021-22).

➣ The forex reserve in USD is still one of the most important measures of a country’s ability to administer trade and services and balance of payment. The healthy forex reserve gives confidence to a country to settle international trade and international payment obligations. Another aim of the Rupee-Dirham deal is to reduce the outflow of dollars, which ultimately helps navigate the balance of payment without negatively affecting the forex reserve.

➣ RBI has made clear that the Rupee-Dirham settlement is not de-dollarization or moving away from the dollar but certainly aims to reduce dependence on it. The Rupee-Dirham deal will protect bilateral trade from geopolitical risks and currency fluctuations. It will also strengthen trading relations and help both countries de-risk their dependence and exposure to the reserve currency, USD. The removal of hedging costs should make India’s export pricing more competitive.

➣ This deal will also help the UAE exporters, giving them more length and breadth to export in India and to reach small importers who traditionally do not have easier access to dollars and do not import because of cost consideration, hedging risk, and dollar depravity.

➣ Going forward, the development of the INR/AED forex market will boost tourism, services, and other areas of cooperation. The UPI in the offering, the Rupee-Dirham deal could be a game changer, though in the long run, not in the short term. The central banks of India and the UAE have signed to cooperate on linking India’s Unified Payments Interface (UPI) with the UAE’s Instant Payment Platform (IPP) and RuPay switch and UAESWITCH which will make fast, safe and cost-effective cross-border transfers. This can also contribute a bit in popularizing the Rupee-Dirham ecosystem.

Thus, it is a win-win situation for both the countries and their traders, but ground realities have made it difficult to reach the envisaged potential. Some of the pain points and practical difficulties that have caused it to be a slow starter (though, it was envisaged also that it would be a slow starter, but not so slow) are enumerated here:

Problems

The three major impediments in the Rupee-Dirham deal are, the trade imbalance causing the problem of settlement or investment of the surplus in one currency; the volatility of rupees causing the value erosion (AED is pegged with USD); and the non-existent forex market wherein no banks or financial institutions are giving the active commercial rate quote between INR/AED to a larger level (retail INR/AED quote for exchange and remittances are not good enough to settle this type of envisaged INR/AED deals).

➣ Another practical concern is a scarcity of counterparties in UAE who will find the use of rupees to buy from India. Unless the trade imbalance is brought down to some extent, the neutrality of the INR/AED on the forex side can’t be insured, and the two parties should not lose money in case the currency depreciates,

➣ Normally exporters will prefer the dollar/Euro because of the availability of the forward premium, which yields additional benefits (approximately 2-4% depending upon the cycle). While exporting in local currency, they lose this premium, but at the same time, they are also insulated from exchange risk. In addition, they might be able to reduce transaction costs and make fast payments. However, for this, the cost of banking and transactions must also be reasonable. There is quite a difference in transaction and banking costs between the two countries.

➣ Lack of the forex market dealing in INR/AED is another factor wherein the major players are not entering the Rupee-Dirham settlement. No readymade market for many Indian products; hence, the trade deficit leaves the traders with high INR and no avenue for the use of these funds. Thus, the exchange rate and currency risks are not easily offsetable because of the lack of derivatives or forward contracts directly in these two currencies without referring to cross currency where the dollar is a player.

➣ One important and practical constraint in the Rupee-Dirham deal is the lack of opportunity to use the surplus currency, in this instance, INR. But it is not only restricted to INR, the exporters in India also face the same problem if paid in AED. What will they do with this currency unless it is used to effect the import payment to India in AED? In a maximum number of cases, the same exporter will not have an import requirement. Hence he needs to either get it back in his country or invest in the country where the export has been made. If it is to go back to his country, there has to be a mechanism wherein the market quote for the two currencies is easily available and favourable compared to USD-INR.

➣ In one of the meetings attended by the UAE Banks Federation, RBI, and the CBUAE, the local banks demanded that a certain interest be paid on the money surplus lying in Indian bank accounts (SRVA) to make it attractive. RBI has proposed that the surplus money can be invested in the Indian market and assets that the regulators permit. There is a growing market in India that the UAE entities can explore.

➣ In the same meeting, another demand was that the two countries’ central banks enable a bilateral line in their respective currencies for settlement of trade and permit the drawing in case of need to make it more flexible and practical.

➣ One of the important pain points that has emerged during discussions with the local banks is that there is not enough demand from the local exporters. Thus, banks are also not finding enough traction to open SRVA accounts or enough trade to offer inter-account settlements.

➣ Large corporate and private participation is necessary to stabilise the deal and push for the Rupee-Dirham settlement. However, large corporations are finding comfort in dollars and not finding enough incentive to adopt this additional settlement mechanism.

➣ Smaller participants are still unaware of the mechanism and how to proceed. Thus, a lack of knowledge and lack of promotion, and awareness is also one cause of concern. Many small traders, especially those in the MSME/SME sector, do not feel very confident because they have not been convinced through promotion, awareness campaigns, etc. It has remained mainly within the bankers and some platforms having limited access. even if some deals are coming through, these are mainly having India connect which is not sufficient to take off this mechanism for a sustainable future.

Solutions, not procrastination

Despite some hurdles, overall, the Rupee-Dirham exchange mechanism is an important positive development for both economies. It allows both the economy to reduce dependence upon the dollar while promoting bilateral trade and countering geopolitical risks to a large extent. For businessmen and exporters/traders, it also provides the opportunity for enhanced trade, the potential to save businesses money, reduce transaction costs, and boost trade. For the consumers, it will provide cost-effective products in the long run. This is a significant step forward in the economic relationship between India and the UAE. The new mechanism will also provide opportunities for the UAE to develop a supply chain from India as an alternative to China and other countries.

It can also help in trade, tourism, and other areas of cooperation like knowledge and services, as well as working on some of the shared ideologies and areas of business. It can also pave the way for connectivity of the unified payment systems of both countries and cross-border settlement through digital mode.

Let us explore the solution to the impediments and how the pain points could be lessened.
One of the statements quoted in the Businessline, w.r.to India-Russia trade settlement in rupees sums up both, the problem and the solution. “The Indian government and the RBI worked with Moscow to create suitable avenues for investment and increase Indian exports to Russia. That seems to have worked,”

1. Learning from Russia

India is paying Russia for oil and defence deals in rupee since trade and other restrictions on Russia in the wake of the Russia-Ukraine war. Since India had very less exports to Russia, the trade deficit caused a piling of INR in the Russian Vostro account. To facilitate the productive use of the rupee lying in the vostro account for the Russian entities RBI also came out with some relaxations providing avenues for investment. Much of the estimated $8 billion in Vostro accounts have been used to pay for imports, investment in infra projects, equity market, and government securities The Indian imports also increased about 39% to $4.05 billion in 2023.

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The Russian entities were permitted to invest in the Government Securities and Treasury Bills through a rupee account. The new system is apart from options to invest through the Foreign Portfolio Investor (FPI) route and Special Rupee Vostro Account (SRVA).

The Reserve Bank of India amended Foreign Exchange Management (Debt Instruments) Regulations, 2019 wherein a new provision has been added to the schedule of the regulation, which says, “Persons resident outside India that maintain a rupee account in terms of regulation 7(1) of Foreign Exchange Management (Deposit) Regulations, 2016 may purchase or sell dated Government Securities/treasury bills, as per terms and conditions specified by the Reserve Bank.” The notification further says that the amount of consideration for the purchase of dated Government Securities/treasury bills by persons resident outside India shall be paid out of funds held in their rupee account and the proceeds shall be credited to the said rupee account.

2. Reduction of trade deficit and increase of business

Indian exports to Russia increased with the implementation of the INR settlement for Russian trade; however, India and the UAE can find more avenues for the trade. Indi can help the UAE become a manufacturing hub and provide a supply chain alternative to China. UAE has renewed its focus on MSME, and the Rupee-Dirham settlement can provide a boost to the small and medium countries across the border in both countries.

While oil is India’s major import from the UAE, its exports to the country include jewelry, refined petroleum products, food, textiles, and machinery. The two countries can collaborate in areas such as technology, renewable energy, infrastructure development, tourism, and healthcare, which will help further strengthen their bilateral relationship.

Encouraging more exports to UAE to bring the trade parity, CEPA is a very positive step. While the deficit can’t be turned overnight Indian companies can derive the benefit of CEPA and the INR/AED settlement mechanism combined together to have better export prospects. Even the plan of setting the Bharat Mart in the line of Dragon Mart is the right step in this direction which will yield the desired result. Both countries must identify a few areas of interest and make concerted efforts to make it possible. UAE is keen on green energy and food security, besides focusing on the IT sector. India can help it in this and boost exports to reduce the deficit.

3. Forex market

One of the most important factors is to create an active treasury market for quotes in forward and future markets, as well as currency and interest derivatives. A free market quote without referring to USD (even in Yen and some other currencies, a cross-currency quote is given) is important to develop confidence and sentiment. As long as the dollar is cheaper, the exporters will move to it or the free market will make it possible for the deals to move towards it. Arbitrage opportunities are good but initially, it will hurt this deal because if INR/AED is not beneficial, the other side will move to direct taking of USD.

While data on such cross-currency trade volumes is not publicly available, the current volume is low, and this may act as a hurdle for corporates to pay for the entire import in dirhams. The bilateral credit line is important in this regard for easy settlement and the involvement of big banks and financial institutions who can actively be the market makers. The ability of SBI, being the largest bank in India, the Largest deal maker as well as the market maker in rupee, and a very robust balance sheet size will make it a very strong player to take this mechanism to the desirable level.

Banks can also contemplate giving the notional limit for derivative transactions which can be used for hedging or arbitrage as is being done in India by the corporates under the permissible limit set by RBI, which includes the contracted exposure (CE) and the anticipated exposure (AE).

The Central banks also want the ready market to be developed as a natural progression for the INR/AED currency pair wherein quotes for the longer period as well as for derivatives transactions should be available, which will help in capital investment deals also going forward.

In one of the meetings wherein the matter of interest rate on the placement of rupee surplus, came in, the RBI representative had made it clear that once the volume increases and it reaches a certain level the central bank will be ready to support banks with INR-AED trades within the permitted framework, however, the current avenues of the investment are available.

4. Promotion and awareness

The small players and exporters are not very clear about the mechanism. There is a need to have more promotion, clarification, and sessions about the benefits of this mechanism. The legality of the forex mechanism, the process flow, and how to use money or the float lying in the bank accounts, to borrow the funds for local settlement if the funds are not available in the local currency are other concerns.

Thus, awareness must be required of the mechanism and its nuances, and the frequently asked questions regarding the Rupee-Dirham settlement be prepared and information disseminated at various forums. Banks as well as other related institutions, and trade bodies be enrolled to make the end user aware and build confidence as well as convince them to use it.

5. Participation and incentives

The Rupee-Dirham deal has not attracted the large players, which is ultimately required to make this mechanism successful, considering their large Balance sheet size. As reported by the Economic Times, the RBI may consider setting internal targets for the quantum of India-UAE trade it would like to see moved away from dollars. This is not a bad idea because a nudge is required to push it through.

The public sector or GRE to PSU deals are not going to make it successful; important is the participation of the private sector which can make it more comprehensive.

While banks can play an important role in advising their customers to use this route, incentives include reduced forex settlement costs, reduced transaction costs, discounted service charges, etc. as an incentive.

6. Credit line for settlement and bank participation

There is a demand for the establishment of a bilateral line that should be enabled by the central banks of the two countries in their respective currencies for settlement of trade as well as permitting the drawing in case of need to make it more flexible and practical.

However, practically it can be made effective through the two largest banks of the two countries which can be entrusted to operationalize the mechanism of providing the bilateral line in the local currencies. State Bank of India has provided a line of credit to Sri Lanka on behalf of the government earlier.

There is a requirement for the participation of active banks from both sides and SBI, being the largest bank in India, can play an active role in taking this mechanism to the breadth of the country (India) and at the same time facilitate the deals in UAE. Being the largest player in the rupee market, it can provide a very strong platform for the settlement.

However, there is one impediment of SBI, not being able to deal in Dirham. To facilitate this settlement, SBI is contemplating seeking a license for retail business in the UAE.

BRICS Bank, the New Development Bank (NDB), has announced a plan to shift away from the dollar, to issue 30% of loans in local currencies, and to begin with lending in South African and Brazilian currencies. This will pave the way for future funding in the two currencies of INR and AED, which will augur well in the long term for the Rupee-Dirham deal. With UAE joining BRICS, the Rupee-Dirham deal is going to be a trendsetter

Way Forward

The idea of the Rupee-Dirham deal is laudable; however, its actual success will hinge on the extent of adoption by businesses in both nations.

Views expressed by Dr. Nilay Ranjan Singh, Chief Executive Officer, State Bank of India, DIFC, Dubai, UAE

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