What’s happening?
The Central Bank of UAE (CBUAE) and the Reserve Bank of India (RBI) have agreed to a bilateral swap agreement worth $2 billion each. This will give each central bank access to the other currency in the event of a short-term liquidity requirement. The RBI and CBUAE are also collaborating to connect their payment systems, the Unified Payments Interface (UPI) and the UAE National Payments Network (NEFT), respectively. As a result, sending and receiving money between India and the UAE would be quicker and easier. The first trade transaction under the agreement went through in July 2023, when Peekay Intermark Ltd. and YES Bank closed a gold transaction in Indian rupees (INR).
India and the UAE had never exchanged local currencies before. The agreement also reflects an increasing tendency toward de-dollarization. Countries are seeking ways to minimize their reliance on the US dollar in international trade and finance. China and Russia agreed to trade in local currencies in 2019, and China and Saudi Arabia agreed to a $10 billion currency swap in 2019. In 2020, Turkey and Saudi Arabia also agreed to a $5 billion trade in local currencies.
What’s causing this to happen?
The Indian government has said that the pact is a significant step towards de-dollarization. Both nations consider the pact an opportunity to strengthen their economic connections. The agreement will facilitate trade between the two nations’ businesses, which will spur economic expansion. Both nations’ concerns about the US dollar’s volatility are another reason for the pact.
Indian Prime Minister Narendra Modi said that the Memorandum of Understanding (MoU) on establishing a framework for the use of local currencies for transactions between India and the UAE is a very important aspect of India-UAE cooperation. He also said that it paves the way for enhanced economic collaboration and will make international financial interactions simpler.
The Local Currency Settlement System (LCSS) will allow businesses in India and the UAE to settle their transactions in their own currencies without having to convert them into the US dollar. This will improve trade between the two countries and help lessen exchange rate volatility. The focus on denominating export contracts and invoices in the local currency is a positive development for the Indian economy. It can help reduce exchange rate risks for Indian businesses and make them more competitive in international markets.
In a report, the International Monetary Fund (IMF) stated in November 2022 that the average cost of sending remittances is around 6%. This means that for every $100 that is remitted, the sender loses $6. The cost of sending remittances from India to the UAE is around 3%, while the cost of sending remittances from India to the United States is around 7%. The UPI-IPP (instant payment platform in the UAE) linkage will allow people to send remittances from India to the UAE in real time. This will reduce the need for banks and money transfer operators, which can help lower the costs of sending remittances.
PM Modi also said that India-UAE trade witnessed a 20% increase since the signing of the Comprehensive Economic Partnership Agreement (CEPA) last year in February 2022. The CEPA entered into force on May 1, 2023, and boosted trade between India and the UAE by 30% in the first two months, up to $100 billion from $85 billion.
What could happen next?
More countries could sign agreements to trade in local currencies. This will reduce the use of the US dollar in international trade and finance. US Treasury Secretary Janet Yellen said in a congressional hearing on June 14, 2023, that the US should expect a gradual decline in the dollar’s share of the global reserve as the global de-dollarization move gains momentum. She added that while the US dollar remains the world’s reserve currency, its dominance is under threat from a number of factors, including China’s rise and the growing use of cryptocurrencies. She said that the US should be prepared for the dollar’s share of the global reserve to decline gradually, but that it is still likely to remain the world’s reserve currency for the foreseeable future. The US Treasury Department and the Federal Reserve Bank of New York work to make it easy for foreign investors to buy and sell US dollar-denominated assets. Also, the US government is working to tax cryptocurrency transactions to maintain dollar dominance. It is a 30% capital gains tax on cryptocurrency profits, similar to that applied to other assets such as stocks and bonds, by 2026.
Economic leveraging of the US dollar and the imposition of US sanctions on perceived adversaries have made other countries wary of using the US dollar in their financial transactions. As a result, countries like Iran and Russia are working to eliminate the dollar’s dominance as the global reserve currency altogether, and China and other major Asian economies like India and Malaysia have backed similar de-dollarization initiatives.
The RBI allowed banks from 18 countries to open Special Vostro Rupee Accounts (SVRAs) in India. These accounts allow foreign banks to hold Indian rupees, which can then be used to settle payments between India and those countries. The SVRAs are a part of the RBI’s efforts to promote the use of the Indian rupee in international trade and finance. The RBI believes that the SVRAs will make it easier for businesses in India and those 18 countries to trade with each other. The 18 nations are Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, Myanmar, New Zealand, Oman, Russia, Seychelles, Singapore, Sri Lanka, Tanzania, Uganda, and the United Kingdom. This could lead to increased competition for the US dollar and put downward pressure on its value.
The US government has not yet commented on the SVRAs, but it could impose sanctions on India or other countries that use the SVRAs. The US government could also try to persuade other countries to continue using the US dollar in international trade and finance.
Individuals and business owners in the US should be aware of the de-dollarization trend and its potential implications for their finances. Diversifying investments into currencies other than the US dollar can help reduce exposure to the volatility of the US dollar exchange rate. Learning about the different currencies, the risks, and the benefits of each can help them make informed decisions about where to invest wisely.
Resources :
- India, UAE sign pact to trade in local currencies amid PM Modi’s visit
- RBI, CBUAE Sign Pacts To Promote Use Of Rupee, UAE Dirham For Cross-Border Transactions
- Going beyond $: India, UAE sign rupee-dirham trade pact
- Remarks by Secretary of the Treasury Janet L. Yellen at PosiGen in New Orleans, Louisiana
- International Trade Settlement in Indian Rupees (INR)
- How Do Transaction Costs Influence Remittances
