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17th July 2023 (8 Topics)

India and UAE Currency Exchange to facilitate Trade

Context

Recently, India signed two memoranda of understanding (MoU) between the Reserve Bank of India and the Central Bank of the United Arab Emirates to increase the circulation of Rupee.

  • The step was taken in line with the emerging future threats of dollar dominance, currency manipulation and Russia’s sanctions.

About the Agreement:

  • The first agreement between the RBI and the UAE Central Bank will establish a framework to “promote the use of local currencies (rupee and dirham) for cross border transactions.”
  • The other MoU between the two central banks is aimed at interlinking their “payment and messaging systems.”
  • Significance:
    • Such cooperation will also include the mutual acceptance of domestic card schemes by interlinking national card switches.
    • Integration between these systems will enhance access to payment services for the benefit of the citizens and residents of the two countries.
  • Other points of discussion:
    • The agenda of the groupings such as the I2U2 (India, Israel, UAE and USA) and the UAE-France-India trilateral cooperation under which both sides are in collaboration with other powers.
    • Also, the two leaders also witnessed the signing of a MoU on establishing a branch of the Indian Institute of Technology-Delhi in Abu Dhabi.

How Currency exchange helps in Trade facilitation?

  • Easy documentation: Trade facilitation covers the full spectrum of border procedures, from the electronic exchange of data about a shipment, to the simplification and harmonisation of trade documents, to the possibility to appeal administrative decisions by border agencies.
  • Fixed rate of transaction: Foreign exchange markets provide a way to hedge currency risk by fixing a rate at which the transaction will be completed.
  • A lower-valued currency makes a country's imports more expensive and its exports less expensive in foreign markets.
  • A higher exchange rate can be expected to worsen a country's balance of trade, while a lower exchange rate can be expected to improve it.

How exchange rate affects Trade?

  • An increase in exchange rates reduces the balance of trade in a country by reducing exports and increasing imports.
  • If a country's imports are valued higher than their exports, the country is said to have a trade deficit and a lower demand for their currency. This drives the currency exchange rate down.

India’s step in similar lines:

  • According to reports, 18 countries have agreed to trade in Indian rupees.
    • These 18 nations include Botswana, Fiji, Germany, Guyana, Israel, Kenya, Malaysia, Mauritius, Myanmar, New Zealand, Oman, Russia, Seychelles, Singapore, Sri Lanka, Tanzania, Uganda and the United Kingdom.
  • These agreements mean that the Indian rupee can be used for trade transactions between the countries involved, rather than relying solely on the US dollar.

Likely Impacts

  • The dollar is the dominant reserve currency by default. The absence of alternatives to the safety of dollar-trade invoicing, international funding markets, and the large supply of guaranteed Treasury bonds suggests that the dollar's role in the global economy is secure.
  • However, the inclusion of China and Russia, and large emerging economies, presents a more potent challenge to dollar dominance than in the past.
  • If sanctions, or some other development, leave other countries dissatisfied, the counter-coalition could grow and pose a more acute defiance against the dollar system.
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