In a landmark move, India and the United Arab Emirates (UAE) have recently signed an agreement that allows trade settlement in rupees instead of dollars. This agreement, signed during Indian Prime Minister Narendra Modi's visit to the UAE, marks a significant step forward for India's efforts to internationalize its currency, the rupee. The shift from dollar-based trade settlement to rupee-based trade settlement carries various implications for both countries and the global financial system. Let's delve into the details of this agreement and explore its benefits and implications. 

India and the UAE share robust trade relations, with bilateral trade reaching $85 billion in 2022. However, the majority of this trade is settled in dollars, necessitating the conversion of rupees into dollars for Indian exporters and the conversion of dollars into rupees for Indian importers. This process incurs costs and exposes businesses to currency fluctuations. The recent agreement aims to address these challenges by enabling trade settlement in rupees, providing several advantages for businesses in both countries. 

The Current Trade Settlement System 

Until now, Indian businesses engaged in trade with the UAE have predominantly relied on dollar-based transactions. This arrangement required currency conversion, leading to additional fees and potential losses due to exchange rate fluctuations. Moreover, it added complexity to the process of conducting trade between the two countries. 

The Agreement for Rupee-based Trade Settlement 

The new agreement between India and the UAE allows businesses in both countries to settle trade in rupees. This shift eliminates the need for currency conversion, saving businesses money on conversion fees and reducing their exposure to currency fluctuations. It also streamlines the trade process and promotes bilateral trade between India and the UAE. 

Benefits of the Agreement 

The agreement carries several benefits for both India and the UAE: 

a. Reduced Reliance on the Dollar 

For India, this agreement helps reduce its reliance on the dollar as the primary settlement currency. Diversifying settlement options strengthens India's economy and makes it more resilient to currency fluctuations. By using the rupee for trade settlement, India can reduce the impact of external economic factors on its domestic economy. 

b. Boost in Exports and Market Access 

The agreement creates favourable conditions for Indian businesses to access the UAE market. With trade settlement in rupees, Indian exporters can offer competitive pricing and payment terms to their UAE counterparts. This increased accessibility and ease of doing business can potentially boost India's exports to the UAE, supporting economic growth. 

c. Diversification of Trading Partners 

For the UAE, the agreement helps diversify its trading partners by promoting trade settlement in local currencies. Reducing reliance on the dollar enhances the UAE's economic resilience and fosters stronger economic ties with countries like India. Diversification mitigates the risks associated with relying solely on a single currency for international trade. 

d. Investment Promotion and Economic Growth 

The agreement is likely to facilitate investment flows between India and the UAE. The ability to settle trade in rupees makes investing in India more attractive for UAE businesses, promoting economic growth in both countries. Increased investment opportunities lead to job creation and the development of mutually beneficial economic partnerships. 

Implications for India and the UAE 

The agreement between India and the UAE carries several significant implications: 

a. Reducing India's Current Account Deficit 

With a shift toward rupee-based trade settlement, India can reduce its current account deficit. By reducing the need for dollar conversion, India can retain more of its foreign exchange earnings and strengthen its financial position. 

b. Attractiveness to International Investors 

International investors may find the rupee a more appealing currency for investment. The agreement signals India's commitment to internationalize its currency and its growing importance in the global financial system. A stronger rupee can attract foreign capital inflows and bolster India's economy. 

c. Boosting India's Economic Growth 

The agreement supports India's economic growth by fostering trade and investment opportunities. Enhanced market access and increased bilateral trade contribute to higher GDP growth rates and overall economic prosperity. 

d. Diversifying the Global Financial System 

The agreement represents a significant development in the global financial system by reducing the dominance of the dollar. As more countries adopt local currency settlement mechanisms, it diversifies the global financial system, making it less reliant on a single currency. This diversification enhances stability and resilience in the face of economic shocks. 

The Global Financial System 

The agreement between India and the UAE has far-reaching implications for the global financial system. It demonstrates a shift toward local currency settlement and away from exclusive reliance on the dollar. This shift promotes a more balanced and robust financial system, enabling countries to conduct trade and investment activities using their respective currencies. 

Key Takeaways 

The agreement between India and the UAE marks a significant milestone in the internationalization of the rupee. By enabling rupee-based trade settlement, the agreement reduces reliance on the dollar, fosters bilateral trade, and promotes investment between the two countries. Moreover, it sets a precedent for similar agreements with other trading partners, contributing to the diversification of the global financial system. As the agreement unfolds, its implementation will shed light on its full potential and impact on India, the UAE, and the global economy.