The recent move by the Reserve Bank of India (RBI) to encourage banks engaged in business with the United Arab Emirates (UAE) to settle part of their trade payments directly in Indian Rupees (INR) and UAE Dirhams (AED) marks a significant shift in India's international trade dynamicsThis initiative comes at a time when India is making efforts to reduce its reliance on the US dollar in the current geopolitical climateThe RBI has also resumed talks with the Central Bank of Russia to expand mechanisms for settling trade in local currencies.

Data from the United Nations Comtrade database underscores the importance of this trade relationship, as the UAE stands as India's third-largest trading partner, with bilateral trade exceeding $80 billion in 2023. The dynamics are clear: the UAE predominantly exports crude oil to India, while India supplies the UAE with refined petrochemicals and electrical appliances

The large Indian diaspora in the UAE contributes significantly to this relationship, as remittances back to India amount to considerable sums each yearThe establishment of a direct settlement mechanism involving INR and AED would help mitigate the losses incurred by these workers due to fluctuations in exchange rates.

This initiative isn't spontaneous; it follows an agreement reached in July 2023 between India and the UAE, whereby both nations expressed their commitment to developing a framework for cross-border trade in local currenciesThe aim was to create a payment system that could serve as an alternative to the globally recognized SWIFT networkSubsequently, the RBI permitted UAE banks to open special INR accounts in India dedicated to trade settlementsThis step encourages importers and exporters to conduct their transactions directly in INR and AED, potentially streamlining the trading process and reducing transaction costs.

In recent developments, the RBI has tasked domestic banks involved in business with the UAE to identify available AED funds through other banks before converting INR to USD and subsequently to AED through international forex markets

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This effort aims to facilitate international transactions while circumventing the dominant position of the dollar— a strategic move reflecting India’s ambitions to create a robust INR-AED foreign exchange marketAlthough this process is still in its nascent stages, the RBI has not imposed strict targets on the UAE, but rather promotes the acceleration of this currency exchange framework.

Industry experts believe that a successful local currency settlement system between India and the UAE could bolster the INR-AED forex market, opening up new opportunities for India’s financial sectorMore significantly, if the INR and AED settlement mechanism becomes well-established, it could set a precedent for India to engage in bilateral currency trade with other nations, deepening the internationalization of the rupee and further reducing dependence on the dollar in global transactions.

To broaden its scope, India is not only focused on the INR-AED mechanism but has also resumed discussions with the Central Bank of Russia to expand their local currency settlement system

This dialogue aims to tackle payment challenges following a surge in bilateral trade in recent yearsThe central banks of both nations are exploring the establishment of a fundamental exchange rate, facilitating painless transactions in non-dollar currenciesIf materialized, this mechanism could have far-reaching positive implications for trade between India and Russia, easing the effects of sanctions imposed on Russia due to geopolitical tensions.

In the short term, reducing dependence on the dollar will help alleviate pressure on India's foreign exchange reserves while minimizing losses stemming from currency volatilityIn the long run, promoting bilateral trade convenience with numerous nations could propel the rupee's international presence, allowing India to capitalize more from global trade engagementsHowever, achieving this objective poses significant challengesCurrently, India's competitive edge in international trade is rather limited, exacerbated by a relatively weak manufacturing sector and domestic demand fluctuations, which often result in export restrictions

According to the World Trade Organization, India's total trade volumes reached approximately $1.1 trillion in 2023, ranking it 14th globally and accounting for only 2.3% of global tradeAnalysts argue that the path toward internationalizing the rupee lacks sufficient support and that other countries must weigh various factors before venturing into local currency settlement discussions with India.

For India to assert itself successfully in this arena, government initiatives that enhance the intrinsic strength and stability of the rupee will be crucialBuilding confidence among the UAE, Russia, and other countries in holding substantial amounts of INR is necessary for fostering a healthier economic environment conducive to bilateral trade agreementsAchieving these ambitious goals requires concerted efforts from policymakers and industry stakeholders to ensure that India emerges as a formidable player in the evolving landscape of global trade.