From the dollar to the rupee: Trade plan between Delhi and Colombo

A move linked to the aim of reducing transaction costs and easing the pressure on foreign exchange reserves. New provisions have also been introduced to allow Indian companies to invest in Sri Lanka using their own currency. However, practical issues remain to be resolved.

Colombo (AsiaNews) - Prioritising local currencies over the dollar: this appears to be the policy being pursued by Delhi in regional trade, a direction also confirmed by the request made to the Colombo government to make greater use of the Indian and Sri Lankan rupees in transactions.

This decision is linked to the aim of reducing transaction costs, easing the pressure on foreign exchange reserves and strengthening economic resilience between the two countries. At a round-table discussion entitled “From rupee to rupee: strengthening the India-Sri Lanka trade corridor” held on 22 June in the capital, the Indian High Commissioner to Sri Lanka, Santosh Jha, expressed the hope that the two closely interconnected economies might conduct commercial and financial transactions more easily.

Alongside the High Commissioner, the initiative is being promoted by the Central Bank of Sri Lanka (CBSL), which aims to pave the way for Sri Lankan credit institutions and branches of Indian banks in Colombo to facilitate trade transactions directly in Indian rupees (INR). To date, despite the close trade ties between India and Sri Lanka, trade has traditionally been conducted using the US dollar.

As High Commissioner Jha pointed out, “every time an Indian exporter issues an invoice in US dollars and every time a Sri Lankan importer pays in US dollars, both parties assume an unnecessary currency risk”. Furthermore, he continues, “they incur unnecessary conversion costs and add an extra layer of dependence on a third-country currency that neither of them issues, controls or, in some cases, can easily acquire”.

Consequently, he warns, “risk reduction and diversification have become increasingly important in an uncertain global economic environment. Relying on a single, dominant method of transaction in a highly unstable world is extremely risky. New sources of resilience need to be created.”

“Local-currency settlement,” Jha continues, “offers a practical solution to many of these challenges. By enabling trade to be conducted directly in rupees, businesses can avoid conversion losses, reduce transaction costs and protect bilateral trade from fluctuations in the US dollar. Local-currency settlement changes this landscape. It reduces transaction costs and eliminates conversion losses in both directions.

And it protects bilateral trade,” the expert concluded, “from the volatility of the dollar.” Speaking at the forum, Aditya Gaiha, Managing Director of the Reserve Bank of India, stated that “key measures include the recent amendments to India’s Foreign Exchange Management Act (FEMA), aimed at strengthening the regulatory framework for foreign exchange transactions”.

Meanwhile, new provisions have also been introduced to allow Indian companies to make direct investments in Sri Lankan firms using the Indian rupee, thereby facilitating cross-border trade and investment. This move reflects a strategic effort to strengthen economic ties, “whilst at the same time,” Gaiha emphasises, “simplifying financial interactions between the two countries”.

When interviewed by AsiaNews, economic analysts Rajini Gamlath and Mayantha Senanayake revealed that “given the relatively low volatility between the INR and the LKR compared to that between the US dollar and the LKR, it could be advantageous to maintain an open exposure to the Indian and Sri Lankan rupees, rather than an exposure to the US dollar and the Sri Lankan rupee”. Therefore, the possibility of hedging exposure to the Indian rupee through foreign exchange forwards (FX Forwards), subject to regulatory approval, “will allow,” they add, “a smoother transition for both importers and exporters seeking direct settlements in INR, as it would provide certainty regarding cash flows compared to maintaining an open position”.

“Meanwhile,” state Gamlath and Senanayake, “the volume of Indian trade handled by most commercial banks in transactions denominated in Indian rupees amounts to around 5–10 per cent, whilst the remainder is in US dollars. It is therefore necessary to increase the volume in INR to 50–60 per cent.

However, forward rates in Indian rupees are not yet available to local banks,” and challenges persist regarding payments for commercial services such as transport costs, with some Indian banks reluctant to handle consultancy fees. “Therefore,” they conclude, “it is necessary to facilitate the resolution of these issues so that rupee-to-rupee transactions can become more attractive.”