India and UAE's trade settlement

India is UAE’s second-largest trading partner, accounting for 9% of its aggregate foreign trade & 14% of non-oil exports. India and UAE’s bilateral trade value stands at $76.16 billion.

This comes as good news as we are on track to improve our trade relations with the United Arab Emirates, while the country’s dependence on countries like USA and China reduces. China’s bilateral trade value with China has even fallen by 1.5% over the last year to $113.83 billion.

Now, did you notice how reading the figures of trade value was difficult due to the usage of US Dollars instead of Rupees, the currency we are more familiar with? To truly gauge the value of these numbers in a familiar context, we needed to convert these figures to Rupees.

The same problem exists on a macroeconomic level as well. International trade between India and countries that are not the US usually use the Dollar as a common currency. This does not make a lot of sense since two countries engaging in trade should use currencies that are contextual to their economies. Recent trends with the US’ economic instability have only given greater incentive to various countries to ditch the Dollar. Read about the US’ money trouble here.

In a recent statement, even the RBI has asked banks to start using the dirham to settle trades between India and the UAE. Well, this article can be very informative for you if you are curious about International Trade and its impact on our Indian Economy and how going “internationally local” with currencies will affect things.

India and UAE's Trade Treaty

So basically, the Indian and UAE governments have jointly decided to use the local currencies of both nations (Rupee & Dirham) for cross-border transactions. The governors of the Reserve Bank of India and the Central Bank of the United Arab Emirates exchanged MoUs (Memorandum of Understanding) on Saturday, July 15, 2023.

Now, all this might seem very simple on paper, but there are a lot of implications to this decision.

The signing of the treaty was witnessed by UAE President Sheikh Mohamed bin Zayed Al Nahyan and Prime Minister Narendra Modi.

The talks on promoting bilateral trade in the Rupee & Dirham were started in March 2022 and it has been over a year since then. To improve bilateral trade and economic ties, India and the UAE have already implemented a Free Trade Agreement (FTA) in May last year.

According to the Commerce and Industry Minister, Piyush Goyal, the apex banks of both countries were discussing the standard operating procedures and modalities to get a better outcome very soon. He interacted with the reporters on 13th June 2023 and made some positive statements regarding the agreement.

Opening up special Rupee Vostro accounts with their foreign counterparts to facilitate cross-border trade in local currencies can possibly be their next step.

You will be shocked to discover that India exported 7,602 commodities to UAE in FY-2021. India’s export to UAE stood at US$ 20.8 billion during April-November 2022. 

What is Bilateral Trade?

Bilateral Trade means the two-directional trade between countries to promote trade and investment opportunities. It is somewhat similar to the barter system and aims at exclusivity between the member countries.

It aims to eliminate barriers and encourage trade and investment opportunities. It is concerned with the balance of payments. Let me make it simple with the help of an example-

There are two countries - India & Russia. India is rich in the production of pulses & jute whereas Russia is the world’s leading natural gas exporter. Both countries want to trade with each other but cannot do so due to various barriers to international trade. As a result, the goods traded between the countries are costlier.

So, the nations decide to sign a treaty to eliminate the different barriers like - tariffs, import quotas & other barriers coming along the way. And it is what we call “bilateral trade”. 

Bilateral trade is an agreement to promote trade and investment opportunities and strengthen the economic relations between countries. 

The Reason behind the Decision

India and UAE are projected to surpass bilateral trade value of US$ 88 billion this year. UAE is also the 7th largest investor in India with cumulative FDI inflows of US$15,179 million from April 2000 – September 2022. 3.5 million Indians living in the UAE, composing 30% of the country’s population. Indians are the largest expatriate community in the UAE as well, and their remittances are a significant source of foreign earnings.

Thus, it only made sense to make the exchanges between the countries as efficient and beneficial for the participants as possible. On paper, the setup would help in the following ways:

• The arrangement is being made to promote investments and remittances between the two nations.
• Using local currencies will reduce transaction costs and settlement time (including the remittances by Indians in the UAE).
• Moreover, the dependence upon Dollars will be minimized. As an effect, the Dollar’s instability would not affect the transactions between UAE and India anymore.

Positive consequences of the treaty

The value of a currency is very crucial when it comes to determining prices in international trade. You must be familiar with these two terms - Currency appreciation & currency depreciation. If not, let me make it clear to you-

Currency appreciation means when the value of a currency increases over a while. On the other hand, currency depreciation means when the value of a currency decreases over a while. The supply of a currency in concern affects its value, both in the international as well as domestic markets. Excess supply of a currency often leads to a fall in its value, causing inflation as a result of the currency deflation, and vice versa.

What makes this treaty more significant is that earlier, all the transactions between India and UAE were used to settle in US Dollars only. But after this treaty, the local currencies of both nations will replace the US Dollar which makes de-Dollarisation particularly significant.

At the moment, Inflation - a significant economic indicator comes into play. Inflation is generally defined as “the rate of increase in prices over some time”. 

As inflation increases in an economy, it reduces the buying power of a currency. Through this treaty, India and UAE will have more control over controlling the inflation and balancing the cost of living in the nations.

Negative Consequences we shouldn’t Ignore

Every coin has two sides, and so does this treaty. Though we have already witnessed the positive consequences of this treaty, how could we ignore the negative ones? Here are some aspects of the treaty that leave a lot to be wanted.

• Switching from the U.S. Dollar to other local currencies would require major economic adjustments. 
• As the Dollar is the most acceptable mode of exchange popularized in International trade, multiple countries have accepted it as the common trade currency.
  While the Dollar’s acceptance affords it a monopoly, a single currency also brought convenience. This convenience could be stakes as similar arrangements take place with other countries.
• It is a time taking procedure that will take potential opportunities along with it till the actual action will come into play.

Is Dollar a Reliable Currency?

Though the Dollar is a widely accepted medium of exchange in international markets, is it a reliable currency for international transactions? Well, not really.

If you have witnessed the currencies market over a while, you must have noticed the significant change in the value of the dollar. During its highs, it reached an all-time high of ₹83.268.

During these “highs”, trades with the US become less affordable for its partner countries. And with globalisation, international trade forms an important part of the goods and services in various economies. Thus, as the Dollar rises, the prices of goods imported through the US Dollar rise, leading to inflation in the consumers' basket of goods.

This inflation may sometimes set off a chain reaction in weaker economies, as when inflation is high, the central banks increase the interest rates. As a result, the loans become more expensive for households and business houses, reducing capital flow in the economy.

This has a direct impact on the production cost of domestic goods and services, which affects the demand and supply of goods & services in the economy. When the demand for good increases significantly and the supply js comparatively falls short, it further exaggerates the effects of inflation.

The Bottom Line

So, switching from the US Dollar as the dominant currency to using local currencies will benefit the nations in many ways as stated below:

• It will control the inflation rate.
• The settlement time of funds will be reduced considerably.
• It will act as an alternative for making international payments.
• It will reduce transaction costs significantly.
• Last, but not the least - It will improve the economic relations with the countries involved in the trade.

My view on the article goes that it was a mandatory step to sign a treaty and use local currencies to make goods cheaper and bring down the inflation rate. It will be a relaxation for the end-user consumer that the prices of those goods and services will come down. 

The Dollar may no longer enjoy the dominant position in the international markets , but economies across the globe may come off better for it.