India and Sri Lanka promoting a shift from traditional dollar-based currency By Arundathie Abeysinghe
India has called for a greater shift towards local currency trade settlement with Sri Lanka, so, the increased use of the Indian Rupee and Sri Lankan Rupee could reduce transaction costs, ease pressure on foreign exchange reserves and strengthen economic resilience between the two countries. At a roundtable discussion titled “Rupee to Rupee: Strengthening the India-Sri Lanka Commercial Corridor” in Colombo last month, Indian High Commissioner to Sri Lanka, Santosh Jha was of the view that the two closely connected economies could conduct trade and financial transactions easily.
This initiative is promoted by the High Commissioner and the Central Bank of Sri Lanka (CBSL), paving the way for Sri Lankan banks and Indian bank branches in Colombo to ease trade transactions directly in Indian rupees (INR).
Despite the close commercial links between India and Sri Lanka, trade has traditionally been conducted through the US dollar.
As revealed by High Commissioner Jha, “every time an Indian exporter invoices in US dollars, and every time a Sri Lankan importer pays in US dollars, both sides are carrying unnecessary currency risk, paying unnecessary conversion costs, and adding a layer of dependency on a third-country currency that neither of them issues, controls, or, in some cases, finds easy to acquire. Hence, de-risking and diversification have become increasingly important in an uncertain global economic environment. Relying on any one predominant mode of transaction in a highly disruptive world is extremely risky. There is a need to create new nodes of resilience.”
“Local currency settlement offers a practical solution to many of these challenges. By enabling trade to be conducted directly in rupees, businesses can avoid conversion losses, reduce transaction costs and shield bilateral trade from fluctuations in the US dollar. Local currency settlement changes that calculus. It reduces transaction costs and eliminates conversion losses in both directions. It insulates bilateral trade from dollar volatility.”
At the forum, Chief General Manager of the Reserve Bank of India Dr. Aditya Gaiha, while delivering a presentation with regard to initiatives aimed at promoting local currency settlements. was of the view that “key measures include recent amendments to India’s Foreign Exchange Management Act (FEMA) designed to enhance the framework for currency transactions. Meanwhile, new provisions have also been introduced to allow Indian businesses to make direct investments in Sri Lankan enterprises using Indian Rupees, thereby facilitating cross-border trade and investment which reflect a strategic effort to strengthen economic ties, while streamlining financial interactions between the two countries.”
Economic analysts are of the view that “due to the relatively low volatility between INR and LKR compared to USD and LKR, one may benefit by running an open exposure on INR/LKR, when compared with a USD/LKR exposure. Hence, the ability to hedge INR exposure via FX Forwards, subject to regulatory approvals, will result in a smoother transition for importers as well as exporters aiming for direct settlements in INR, as it would provide certainty over cash flows when compared to running an open position.”
“Meanwhile, the Indian trade volumes handled by majority of commercial banks in INR denominated trade transactions are approximately 5-10 per cent, whereas the rest are in USD. Hence, it is necessary to increase INR based volume up to 50-60 per cent. Yet, INR forward rates are not yet available to local banks. Quotes are only available up to spot, while trade related service payments such as freight charges, some Indian banks are reluctant to handle consultancy fees. Hence, it is necessary to facilitate these issues for Rupee-to-Rupee transactions to gain more traction”.
