Introduction
India’s push to internationalise the rupee and expand bilateral trade settlement in local currencies — most dramatically accelerated by the geopolitical pressures following Russia’s invasion of Ukraine in 2022 — represents one of the most significant monetary policy initiatives of the decade. The RBI’s circular of July 2022, permitting invoicing, payment, and settlement of exports and imports in Indian rupees through a special Vostro account mechanism, was a departure from decades of convention in which India’s international trade was predominantly denominated in US dollars.
The immediate impetus was practical: with Russia under comprehensive Western financial sanctions, Indian companies trading with Russian entities needed an alternative to dollar-based SWIFT payments. Rupee trade settlement offered a route around the sanctions bottleneck. But the initiative has since been framed much more broadly — as a structural effort to reduce India’s dependence on the dollar, build trade relationships denominated in local currencies with multiple partner countries, and gradually establish the rupee as a credible regional trade currency.
The legal architecture of this initiative — the Nostro-Vostro mechanism, the foreign exchange regulatory framework, the correspondent banking relationships required, and the bilateral agreements that support them — raises complex questions of banking law, foreign exchange regulation, and international financial architecture that this article seeks to examine.
Legal Framework
The legal basis for the rupee trade settlement mechanism rests on Section 10(1) of the Foreign Exchange Management Act 1999 (FEMA), which empowers the Reserve Bank to specify the manner and conditions for dealing in foreign exchange. The current account transaction framework under FEMA, which permits full convertibility for trade-related transactions, provides the regulatory foundation for rupee-based trade settlement without requiring capital account liberalisation.
The RBI’s July 2022 circular established the operating framework: an authorised dealer (AD) bank in India can open Special Rupee Vostro Accounts (SRVAs) for correspondent banks in partner countries. The foreign correspondent bank, operating in the partner country’s domestic currency and banking system, holds a rupee-denominated account with an Indian AD bank. Indian exporters receive payment in rupees to these accounts; Indian importers make rupee payments from these accounts. The foreign exporter and importer, on their side, deal in their local currency with their domestic bank, which operates the SRVA relationship with the Indian AD bank.
The bilateral currency swap agreements that India has negotiated with specific countries — most significantly the India-UAE Local Currency Settlement (LCS) agreement, formalised in 2023, and the broader push for rupee settlement with ASEAN countries — provide the diplomatic framework that enables the banking arrangements at the regulatory level.
Contemporary Issues and Analysis
The convertibility asymmetry is the most significant structural tension in the rupee trade settlement model. An Indian exporter who receives rupees through the SRVA mechanism has no problem — rupees are freely usable in India. A Russian or Sri Lankan exporter who receives rupees into their SRVA account faces a different question: what can they do with rupees? They can use them to purchase Indian goods and services, invest in specified Indian financial instruments, or keep them as balances. But they cannot freely convert them to their domestic currency at market rates or use them for transactions outside the India relationship without going through the Indian exchange control framework.
This asymmetry — rupees are freely usable only within India — is the fundamental constraint on the rupee’s potential as an international trade currency. For the mechanism to develop beyond the specific case of Russia (where bilateral trade with India was being disrupted by sanctions), partner countries need sufficient volumes of Indian imports to use their rupee balances. Where bilateral trade is not roughly balanced, a structural surplus of rupees in partner countries’ SRVAs that cannot be profitably deployed represents a cost that limits participation in the mechanism.
The Russia experience has been instructive on this limitation. India’s imports from Russia — primarily crude oil — significantly exceeded India’s exports to Russia, resulting in a large and growing accumulation of rupee balances in Russian banks’ SRVAs. These balances could not easily be repatriated or converted, creating a diplomatic and commercial friction that required ongoing bilateral negotiation about acceptable uses of the rupee surplus.
The sanctions compliance dimension is a continuing legal concern. An AD bank in India that facilitates rupee trade settlement with a sanctioned counterparty — even where the transaction is in rupees and is technically compliant with Indian law — may be exposed to secondary sanctions risk from the United States, which claims extraterritorial jurisdiction over dollar-related transactions and has used secondary sanctions to pressure non-US financial institutions. Indian banks, many of which have significant US correspondent relationships and dollar-denominated balance sheets, have been cautious about rupee trade settlement with Russian entities for precisely this reason.
Comparative and International Perspective
The most instructive comparator is China’s experience with renminbi (RMB) internationalisation, pursued systematically since 2009 through a combination of bilateral swap arrangements, offshore RMB centres (Hong Kong, Singapore, London), and the Cross-Border Interbank Payment System (CIPS) as an alternative to SWIFT for RMB-denominated transactions. China’s RMB internationalisation has achieved significant progress — RMB is now included in the IMF’s Special Drawing Rights (SDR) basket — but its share of global trade invoicing and reserve holdings remains well below its share of global GDP, reflecting the limits of a currency that is not freely convertible on the capital account.
India faces similar constraints, with the additional complication that India’s trade deficit means there is a natural tendency for rupees to flow out of India to pay for imports, making the accumulation of rupee balances abroad structurally more difficult to manage than for a country with a trade surplus.
The ASEAN local currency transaction frameworks, developed through ASEAN multilateral cooperation, offer a model for multi-country bilateral currency settlement arrangements that might be more efficient than India’s current bilaterally negotiated approach.
Practical and Policy Implications
For Indian exporters, rupee trade settlement is straightforwardly advantageous: they receive payment in their home currency, eliminating exchange rate risk. For importers paying in rupees, the advantage depends on the import currency and the exchange rate at which the domestic supplier is willing to settle in rupees — which may not always be competitive with dollar rates.
For Indian banks that operate as AD banks in the SRVA mechanism, the compliance burden and reputational risk are significant considerations. The need to maintain robust sanctions screening, anti-money laundering controls, and correspondent banking compliance standards for SRVA operations — particularly with counterparties in jurisdictions that have known AML weaknesses — is a commercially significant ongoing obligation.
Suggestions and Reforms
India should negotiate bilateral trade settlement frameworks that include provisions for the use of accumulated rupee balances — specifically, permitting partner country banks to invest SRVA balances in Indian government securities (rupee-denominated sovereign debt) as a low-risk, liquid store of value for surplus rupee holdings. This would both support the SRVA mechanism’s utility and deepen the market for Indian sovereign debt.
The RBI should consider establishing an interoperable rupee payment system — analogous to CIPS for the renminbi — that provides an alternative to SWIFT for rupee-denominated bilateral transactions and reduces the sanctions compliance friction associated with dollar correspondent relationships.
Conclusion
India’s rupee trade settlement initiative is a structurally sound long-term policy objective that faces short-term implementation constraints rooted in the rupee’s non-convertibility and the asymmetry of India’s bilateral trade balances. The legal architecture is in place; the diplomatic framework is developing; the banking infrastructure is operational but underutilised. The gap between ambition and reality is not a reason to abandon the initiative — it is a reason to address the specific structural constraints, particularly the convertibility asymmetry and the sanctions exposure of participating AD banks, that are limiting the mechanism’s scale and commercial appeal.
