India: RBI introduces INR settlement mechanism for trade; steady June inflation

New INR settlement mechanism is medium-term constructive for the rupee
Group Research, Radhika Rao13 Jul 2022
    Photo credit: Unsplash Photo

    The RBI announced a new mechanism for INR settlement in international trade, i.e., including invoicing, payment and settlement of the transaction. Marking a step towards eventual internationalisation of the currency, local authorised banks (press release) will be permitted to open INR vostro accounts and open counterparty special rupee vostro accounts of correspondent banks of the partner trading country. This will help Indian importers make payment which will be credited into the special vostro account and exporters get paid in rupees from the balances of these accounts, shielding businesses from exchange rate risks. This move is constructive for the rupee in the medium-term as higher INR demand for settlements implies lower demand for forex for current account transactions. Beyond ironing out near-term regulatory and operational requirements, market observers expect this mechanism to facilitate trade with neighbouring countries, with trading partners who are unable to access dollar funds and/ are temporarily outside the international trading mechanism and those looking to broaden their pool of trade settlement currencies. Eventual take up by the broader trading community will also hinge on partner countries warming up to shouldering the FX translation risks. Spot rupee meanwhile continues to remain under pressure, falling to fresh record lows and closing in on 80/dollar, on a bid dollar and weak risk uptake, joining its AXJ peers, led by underperformers Philippine peso and South Korean Won.  

    June CPI inflation out yesterday was steady from the month before, rising by 7% YoY, with the MoM pace nearly halving from the month before. The sequential deceleration was mainly on account of easing cereals, vegetables, protein, and meat prices, while edible oils stabilised, helped also by a seasonal pullback in the housing segment, offsetting the hike in non-subsidised fuel/ gas variants in the month. Core inflation (ex food and fuel) eased from 6.1% to 5.96%. Looking into the rest of FY23 and assuming global commodity prices stay steady to lower, headline inflation is likely near its peak, helped by smaller than expected hike in the minimum support prices for farm produce and rains catching momentum. July is a crucial month for kharif sowing, when quantum, geographical and spatial spread of the southwest rainfall will be important. Overall, the RBI is likely to progress with incremental rate hikes to narrow the negative real rate spread and keep inflationary expectations anchored.

    Radhika Rao

    Senior Economist – Eurozone, India, Indonesia


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