Imagine that you are one of the leading software exporters in India. Your costs, mainly wages and salaries, are of domestic and rupee denominations. Your customers are mostly in the U.S. and are in Europe; So your revenue is in dollars and euros. Wouldn’t it make sense to invoice your services in rupees so both revenue and cost are in the same currency? This will give your business more predictability in terms of cash flow and contracted values of revenue and costs. This is because fluctuations in exchange rates are more frequent and volatile than changes in wages and household costs. Therefore, the exchange rate risk will be borne by your client. Hedging it will be up to your clients.
It will be hilarious, but you may ask, do domestic regulations really allow exporters to invoice in rupees? Yes, absolutely, and it has been allowed for many years. Then why our exporters don’t invoice in rupees? The Reserve Bank of India (RBI) does not stop them. The main reason is that US customers will simply leave. They do not want to deal with currency risk, and in any case, there are no means available to hedge their rupee exposure in that country. Hence, India’s software giants also have to swallow their pride and invoicing dollars. This is the geopolitical reality of the almighty US dollar. As one famous US Treasury secretary said, “The dollar is our currency, but your headache!” It is not just for Indian exporters. Dollar invoicing is a worldwide phenomenon. 85% of India’s exports are invoiced in dollars, although only 15% of exports are to US shores. To add to the exporter crisis, dollar prices do not fluctuate much with exchange rates; They remain ‘sticky’. If domestic costs increase, the exporter is not compensated with a higher dollar price invoice.
This global phenomenon of dollar invoicing in international trade and its viscosity has significantly weakened if not negated the Mundell Fleming (MF) model of international exchange rates. The MF theory assumes that a weaker domestic currency will lead to an increase in exports. But due to fixed (or sticky) dollar invoices, the exporting country does not benefit. Countries like India also suffer on the other side, as even 97% of its imports are invoiced in dollars. This has given rise to an alternative ‘dominant currency paradigm’ interpretation of international trade, a theory pioneered by Gita Gopinath and others. This explains the disparity in the effect of a weak currency on domestic inflation between developing and developed countries. For the US, almost all of its imports and exports are invoiced in dollars. To that extent, he doesn’t have to worry about currency risk.
There is another reason why the Indian exporter does not want to invoice in rupees. This is because the rupee has an inherently weak bias, so its fall is likely to lead to windfall gains, which may not happen with rupee invoicing. Of course, the US client is equally smart and squeezes the contract to factor in the anticipated gains from the rupee depreciation. The interpretation of rupee-invoicing reluctance for software also applies to other exports. This explains why 5-star hotels in India will not quote prices in rupees to foreign tourists looking for good deals on the internet.
This background of lack of progress in invoicing the rupee, despite policy volatility, should be kept in mind when we evaluate the latest RBI announcement. One of the major exemptions it has given is that the rupee proceeds of exports can be invested in domestic assets, i.e. government bonds. Earlier, these proceeds, which are usually in the Vostro accounts of correspondent banks, had to be posted immediately. It is not clear whether this exemption will lead to exporters participating in the invoicing of Rs. Since now imports can be paid for in rupees, this is certainly a big boost for India-Russia trade. Discounted oil from Russia can be paid for in rupees, which can be used to pay for Indian exports to Russia. This is a clever way of bypassing the actual sanctions on trade with Russia. A few years back, India offered a rupee trade route for oil imports from Iran to evade US sanctions. Since dollar payments are evident in New York, it was necessary to find an alternative settlement mechanism. Iranian suppliers were allowed to operate a special rupee account with Ucobank, which was also used to pay for India’s exports to Iran. The current move to expand rupee-denominated trade is a multilateral version of that bilateral arrangement.
Note that rupee invoicing is far from internationalizing the currency. The latter would require significant steps towards capital account convertibility. This would require the willingness of third countries to settle payments and trade in rupees, and also to have the rupee as a reserve currency. The rupee, in turn, needs to be much more stable than it is now. This would require unlimited access to the buying and selling of Rupees by any entity, be it onshore or offshore. Foreigners’ ability and readiness to invoice in rupees is only a small step in the long journey. Undoubtedly, internationalization would help lower transaction costs and reduce exchange risk for cross-border trade, but it would also mean less autonomy of domestic monetary policy. India’s current parameters of bank asset quality, the size of the fiscal deficit, inflation level and currency weakness mean that internationalization of the rupee is far, and far from inevitable. However, rupee invoicing is a welcome shot for India-Russia trade, and will also help in easing some depreciation pressure.
Ajit Ranade is a Pune-based economist
catch all business News, market news, today’s fresh news events and breaking news Updates on Live Mint. download mint news app To get daily market updates.