Explained: Sri Lanka Using The Indian Rupee For International Trade

In a fillip to the Reserve Bank of India's (RBI) efforts towards the gradual internationalisation of the Indian rupee, a Sri Lankan bank has opened special rupee "vostro" accounts in India to facilitate trade in the Indian rupee. These accounts build on the framework spelt out by the RBI for facilitating international trade in the Indian rupee that it laid out in July.

The Bank of Ceylon, a Sri Lankan bank, has opened a vostro account with the State Bank of India through the former's branch in Chennai.

Reports in Sri Lankan media suggests that this may be the first of many such arrangements.

The move is significant for Sri Lanka who is starved of foreign exchange reserves. As a lion's share of global trade is conducted in United States dollars (US dollars), two countries would normally export and import from each other in US dollars but also in euro, the British pound or yen to a lesser degree. The option to trade with India in Indian rupees offers Sri Lanka respite from dipping into its scarce foreign exchange reserves after months of economic turmoil.

The Sri Lankan central bank also did its part earlier this year to facilite Indian rupee trade, when it added the Indian rupee to its list of 'designated foreign currencies'. The Indian rupees joins a legion of foreign currencies like the US dollar, the yen, the pound, the Swiss franc, the Swedish kroner and the Thai baht on the list (the entire list can be seen here.). This designation allows Sri Lankan entities to use these currencies to conduct offshore commerce and global trade. It even lets Sri Lankan nationals open personal foreign-denominated accounts in these currencies.

Sri Lanka currently permits citizens to have $10,000 worth of foreign currency on them, down from an earlier limit of $15,000 to save on foreign exchange. Through these arrangements, India has permitted Sri Lankan citizens to now hold these $10,000 in Indian rupees (nearly ₹8.14 lakhs) in physical form.

A cross-section of factors like the COVID-19 pandemic, governmental missteps and political unrest has led Sri Lanka into an economic crisis starting in March, marked by a lack of foreign currency, shortages of essentials and mass protests against the government. This led to Sri Lanka to turn to aid and grants from larger countries like China, India and Japan. In September, it struck a staff-level agreement with the International Monetary Fund.

Also Read: Explained: Sri Lanka's Foreign Exchange And Economic Crisis

However, the there is no report to show that the Indian rupee may supplant or supplement the Sri Lankan rupee as legal tender in Sri Lanka. Legal tender is a currency that can be used to settle domestic transactions or debt.

Sri Lanka is not the first country to strike such arrangements with India and banks within it.

In November, India's Commerce Secretary Sunil Barthwal said that India had approved nine vostro accounts for Russian banks. This includes an account for Gazprom through state-owned UCO Bank and Russia's VTB and SverBank with their own Indian branches. The remaining six accounts for Russian entities have been opened by India's IndusInd Bank.

Russia is currently subject to various international sanctions due to its military operations in Ukraine that restricts its ability to trade internationally in prominent global reserve currencies. It has granted India - a major energy importer - discounts on oil and the option to trade with it in Indian rupees.

Also Read: IMF Reaches $2.9 Billion Provisional Loan Agreement With Sri Lanka

What are these special vostro accounts?

To tap into growing interest in more trade in Indian rupees, the RBI introduced the concept of these special rupee vostro accounts in July. These accounts facilitate 'correspondent banking': where an entity (in this case a bank in India) holds and operates an account on behalf of someone else (a foreign entity, normally a foreign bank).

Vostro accounts will be operated by select banks in India but it can also be operated by a foreign bank through its Indian branch. For a foreign entity to open such an account, it must first approach an authorised bank (authorised dealer bank or AD bank) in India. The AD bank must then present its case before the RBI and get its approval to open and operate such an account.

All export and import invoicing between the two countries may be carried out in Indian rupees. When an Indian exporter want to export to the country in question, the exporters can receive Indian rupees from the balance in these vostro accounts. Indian importers who wish to import from such countries may directly deposit Indian rupees into these accounts.

The RBI also suggests that there are no restrictions on remitting the balances of these accounts, and that converting them into foreign currencies would be possible at market determined rates. Surplus balances in these accounts can be invested in government securities or payments for projects and investments.

Is this the first time India is carrying out foreign trade in Indian rupees?

No, as a portion of India's trade with Bhutan and Nepal are already carried out in Indian rupees.

Indian entities have previously undertaken trade with Iran to settle energy transaction in the Indian rupee in 2013 and in 2018. This arrangement was more limited, chiefly to bypass US sanctions on Iran by trading in euro and Indian rupees.

The sanctions on Iran were lifted in 2015 after China, Russia, the United Kingdom, France, the European Union and the US reached an agreement with Iran on oversight over the latter's contentious nuclear program. But they were re-imposed in 2018 by the US under then President Donald Trump when they unilaterally reneged from the agreement.

The vostro account program differs from these earlier attempts to trade in the Indian rupees by giving it greater international prominence by facilitating broader trade with any country.

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