The Reserve Bank of India (RBI) has advised banks that engage in trade with the United Arab Emirates (UAE) to settle a portion of their payments directly in rupees and dirhams. Although the RBI has not specified a target for these transactions, it has requested regular reports on the extent of such settlements from the banks, according to five banking sources who wished to remain anonymous due to their non-authorized status.
Expanding Trade Settlement Options
This initiative marks a step beyond the RBI’s previous encouragement in 2023, which followed Prime Minister Narendra Modi’s visit to the UAE. The move is part of India’s broader strategy to increase the use of the rupee in international trade and reduce dependency on the U.S. dollar. With approximately half of global trade still denominated in dollars, this shift could potentially help India manage its trade balance more effectively.
Mechanism for Local Currency Trade
To facilitate the rupee-dirham transactions, the RBI has suggested that banks should first seek a matching dirham flow from another bank when making payments to the UAE. This approach aims to eliminate the need for currency conversion through dollars, streamlining the process and potentially reducing transaction costs. The UAE is a key trading partner for India, with bilateral trade totaling around $83 billion in the 2023-24 financial year, including over $17 billion in oil imports. Settling trade in local currencies could help mitigate the impact of India’s $12.4 billion trade deficit with the UAE.
Development and Adoption
The RBI has not mandated that all dirham payments be converted through this new channel but is encouraging the establishment of a rupee-dirham market. Banks are expected to become more inclined to seek direct dirham flows rather than converting dirhams to dollars, a practice that currently dominates. While there is openness among banks and clients to adopting this mechanism, the process is still in its early stages, according to a senior banker.
