Vostro accounts to get an RBI upgrade in race to a global rupee

The Reserve Bank of India (RBI) may permit the use of rupee vostro accounts for a wider variety of transactions, two people aware of the plans said, a move that promises to enhance the utility of these accounts and advances the use of the rupee in cross-border trade.

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. The central bank is likely to come up with a new framework on vostro accounts in the next six months, the people cited above said on the condition of anonymity.

According to one of the two people, the RBI may allow the use of vostro funds in cross-border lending and certain capital account transactions. “Additionally, the central bank is also studying the potential of allowing loans to non-resident Indians (NRIs) from the rupee holdings in these accounts,” the person said on the condition of anonymity.

Spokespersons of the RBI and the Union finance ministry didn’t respond to emailed queries.

When an Indian trader needs to pay a foreign trader in rupees, the amount is deposited in the vostro account. Conversely, when a foreign trader needs to pay an Indian trader, the amount is withdrawn from the vostro account and credited to the Indian trader’s regular account.

The latest RBI move ties in with efforts by India’s government and the central bank over the years to promote the use of the local currency in international trade and transactions. In its annual report released in May, the RBI highlighted new steps in this direction, including plans to allow persons residing outside India (PROIs) to open rupee accounts abroad. Additionally, the RBI aims to enable bank lending to PROIs and facilitate foreign direct investment (FDI) and foreign portfolio investment (FPI) through special non-resident rupee and vostro accounts.

Internationalizing the rupee

The central bank’s initiatives to internationalize the rupee and the government’s push to establish it as a hard currency are positive steps, but significant challenges remain, said Ajay Sahai, director general & chief executive officer of the Federation of Indian Export Organisations (FIEO).

Though India has Special Rupee Vostro Account (SRVA) agreements with around 20 countries, only those with Russia, Sri Lanka and the Maldives are currently active, he said, noting that major Indian banks have yet to join the arrangement.

“We’ve taken the first steps, but there’s still a long way to go in promoting rupee-based trade. Many Indian exporters also import goods paid in foreign currency, so they tend to invoice exports in foreign currency, like the US dollar, as a natural hedge against currency fluctuations,” Sahai said.

He also emphasized the need for Indian banks to establish branch offices in SRVA-partner countries, such as Russia. “This journey to internationalize the rupee will take time. Even China, which incentivized yuan transactions nearly two decades ago, sees only about 8% of global trade settled in its currency,” he said.

According to the second person cited earlier, the rupee vostro accounts maintained by foreign institutions with Indian banks play a vital role in promoting international trade in the Indian rupee. “Expanding the use of this money will encourage broader participation from non-resident Indians in the country’s financial ecosystem,” the person added.

New vostro rules could usher in a transformative phase for rupee-denominated international trade, the two people said.

India has allowed banks in 22 countries including Russia and the UK to open vostro accounts in the country, the government told parliament on 8 August 2023, to help facilitate trade in rupees and cut transaction costs.

“I think the RBI’s initiative is in the direction of making India one of the leading countries of the world, both in terms of economic growth and trade relationships, said Bhanumurthy N.R., director at the Madras School of Economics.“India has been reaching out to many other countries, especially in the global south, sharing DPIs (digital public infrastructure) with them. We have an opportunity to use the vostro account transactions with these countries in a bid to internationalize the rupee further,” he said. “It will take time, but we are in the right direction,” he added.

Facilitating lending to NRIs

Meanwhile, by enabling overseas institutions to leverage their rupee deposits held with Indian banks, the RBI also aims to facilitate lending activities, particularly to NRIs with substantial investment interests in India.

“This strategic shift is part of a larger vision to integrate the rupee into global financial markets while enhancing the currency’s usability for foreign entities,” the first person mentioned above said.

In July 2023, Sanjeev Sanyal, a member of Prime Minister Narendra Modi’s Economic Advisory Council, told Mint that the rupee’s hard currency status over the next decade would lead to its inclusion in the International Monetary Fund’s special drawing rights basket, potentially lowering India’s financing costs. A hard currency is a globally traded currency that is considered stable and reliable.

“This move is another step at internationalization of the rupee. This will work if the same can be lent in domestic market and earn higher returns compared with G-Secs as is the case today,” said Madan Sabnavis, chief economist at the Bank of Baroda.

“Lending in rupees outside is a good idea, though it will be contingent on persons or entities outside India who can find use,” he added.

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