Cross-border lending: A new era for the Rupee?
Is the Rupee poised to challenge the dominance of the US dollar?
There is increasing speculation that the Reserve Bank of India (RBI) may permit the use of rupee vostro accounts for cross-border lending and select capital account transactions, marking a significant step toward advancing the internationalisation of the Indian rupee (INR). But what exactly are vostro accounts, and why is this significant?
Vostro: "Your money on deposit at our bank"
Vostro is the Latin shorthand for saying "your" money that is on deposit at our bank. A vostro account is held by a domestic bank on behalf of a foreign bank, which can use it to settle forex transactions, make cross-border payments and make investments in the domestic market, among others.
Mint reported that the central bank is likely to come up with a new framework on vostro accounts in the next six months to do the following:
Allow persons residing outside India (PROIs) to open rupee accounts abroad.
Enable loans to non-resident Indians (NRIs) from rupee holdings in vostro accounts.
Facilitate foreign direct investment (FDI) and foreign portfolio investment (FPI) through vostro and special rupee accounts.
This move signals India's intent to inch closer to a more international role for the rupee. But can the rupee challenge the US dollar’s dominance in global trade and finance? Let’s break it down.
Why the dollar reigns supreme
The US dollar’s dominance isn’t accidental. It rests on two critical pillars:
Liquidity: The US treasury market is vast, mature, and trusted by central banks worldwide.
Stability: Minimal long-term volatility, and global trust in the dollar as a safe haven in times of crisis.
Every global financial shock—be it the Asian Financial Crisis or the Eurozone debt crisis—has seen investors flock to the dollar. Funnily, the US dollar appreciated during the Global Recession, despite the US being the origin of the crisis and the Fed easing the money supply.
The de-dollarisation wave: A growing trend
As powerful as the dollar is, there’s growing interest in reducing dependency on it. Here’s why:
Bypassing sanctions: Countries like India and Russia have bilateral trade agreements to settle in local currencies, sidestepping the dollar’s dominance. However, challenges remain. For example, Russian exporters reportedly hold $8 billion in rupee vostro accounts, but much of it sits idle due to limited investment opportunities in India.
The digital currency push: Cryptocurrencies like Bitcoin offer alternatives to traditional currencies, but their extreme volatility makes them unsuitable for mainstream global trade.
The China question: Despite being the world’s second-largest economy, China’s yuan isn’t ready to rival the dollar. Capital controls and limits on currency convertibility render the yuan's aspirations as a global reserve currency a distant dream. To my mind, the Japanese yen may present a stronger case as a contender.
Cross-border lending & local currency trade: A step, not a leap
Non-resident Indians (NRIs) and other global citizens with ties to India could benefit from new avenues for rupee-denominated loans.
Scenario: An NRI living in Dubai wants to invest in Indian real estate. Access to rupee loans from their vostro account holdings simplifies the process, reducing currency exchange risks and costs.
Outcome: This fosters closer financial ties between NRIs and their home country while unlocking investment potential.
This isn’t just theory. Intra-Europe cross-border lending is a highly competitive landscape that has proven the most beneficial for real estate sector in terms of lending volumes. For India, a similar shift could unlock immense potential, especially in sectors like real estate where lending volumes are high.
Size and sectoral breakdown of non-financial corporations involved in cross-border lending.
Source: European Central Bank
An integrated banking market naturally fosters business growth and international expansion. Case in point, by the end of 2023, approximately 14% of euro area non-financial corporations' turnover was generated from operations in other euro area countries—a trend that has been steadily growing since 2019, albeit unevenly across sectors.
A mere step towards economic sovereignty
Cross-border lending through local currencies reduces dependency on dominant global currencies like the US dollar. It also shields economies from geopolitical risks tied to sanctions or trade restrictions.
Having said that, the rupee has miles to go before it can rival the dollar. Special Rupee Vostro Account (SRVA) agreements with 20 countries, including Russia, Sri Lanka, and the Maldives, are promising. But active use remains limited, underscoring the challenges of scaling bilateral arrangements to global trade. Even so, these agreements carry merit. For example, the Maldives recently struck deals with both India and China to trade in local currencies, potentially saving 50% of its annual $1.5 billion import bill.
Such bilateral arrangements are mutually beneficial, conserving foreign exchange reserves and reducing dependency on the dollar. However, extrapolating this to world trade – to my mind – is a distant fantasy.