History doesn’t just repeat itself, it endures. Consider the rupee-rouble agreement, discussed in every decade from the 1950s, through the 1960s, ’70s, ’80s, ’90s, and the 2000s, up to as recently as 2017. And here it is again now, in 2022. It has been contested, hotly negotiated and frequently renegotiated. Yet, issues have persisted.
In 1961, the then Reserve Bank of India (RBI) Governor, H.V.R. Iengar, wrote to then Prime Minister Jawaharlal Nehru highlighting the risks associated with the 1957 rupee-rouble agreement with the erstwhile USSR. He raised the same concerns about similar agreements signed with some East European countries, wherein we also paid for imports with non-convertible rupees.
RBI officials had found evidence of switch trading or ‘shunting’, where Indian exports paid for with those non-convertible rupees to Poland, Yugoslavia, Czechoslovakia and Hungary were diverted or re-exported to hard currency countries. While not illegal, the central bank believed those actions went against the spirit of the bilateral currency agreements.
In response, Nehru wrote a two-page, hand-written note brushing aside those concerns. He instructed the Ministry of Finance to ignore the Governor’s views, saying “political compulsions far outweigh the economic considerations in this relationship”. The RBI was largely excluded from the policymaking side of this relationship. The central bank did not participate in the negotiations after that, other than as advisor to the government on certain technical aspects of bilateral trade. A fuller analysis of this period and events can be found in the History of the Reserve Bank, Appendix G. But now, the RBI finds itself leading the current round of talks.
Is a new rupee-rouble agreement advisable, or even desirable? Three questions jostle for attention. First, how much will India benefit from such an agreement? Second, should it cover specific products and services, and how should the exchange rate be decided? Lastly, what kind of impact will this have on the rupee’s value in global foreign exchange markets?
On March 18, Russia’s new Ambassador to India, Denis Alipov, said that his country would be willing to buy almost all of its pharmaceutical needs from India. In early April, Russia’s Foreign Minister, Sergei Lavrov, came to Delhi and met Prime Minister Narendra Modi to perhaps reinforce, among other things, a significant expansion of mutual trade. India’s pharma industry currently meets $600 million of Russia’s $8.9 billion in imports, 80 per cent of which is from Europe, mainly Germany and France.
Compare that to roughly $3 billion in total exports, and the possibilities look extremely attractive, especially since pharmaceuticals are exempt from sanctions imposed on Russia in the wake of the Ukraine conflict. At $10 billion, Russia currently accounts for just 1.24 per cent of India’s trade (imports and exports). Imports (oil, gas, coal and nitrogenous fertilisers) are more than twice exports, so achieving trade balance with a rupee-rouble agreement in place seems like a great opportunity.
That was one of the major objectives behind the bilateral rupee agreements of 1958-59: to increase trade with the USSR and the East European economies, and for a while it succeeded. According to the RBI, which closely tracked the data in its role of implementing the agreements, trade went up from $9.2 million, or 0.3 per cent of India’s total trade in 1952-53, to $658 million, or 14.2 per cent in 1965-66. But the balance of trade was skewed; imports from the USSR exceeded exports from India to the USSR by a wide margin, and the rupee balances in Soviet Union’s accounts with the RBI kept piling up.
“Even after the termination of the rupee-rouble agreement in 1992, it took Russia—the successor state to the USSR—more than 16 years to liquidate the rupee balances it held with the RBI,” says Pronab Sen, former chief statistician of India and ex-secretary in the Ministry of Statistics and Programme Implementation. Sen has written on this extensively, including a paper for the erstwhile Planning Commission, in 1990.
But many exporters believe that a new bilateral rupee-rouble agreement will be beneficial, and not just because it would ease payment realisation. The core problem in the past—in fact, the root of most disagreements—has been on how the exchange rate between the rupee and the rouble was set. The new agreement, it’s expected, will fix that.
Didn’t pay the piper‚ couldn’t call the tune
Until the first half of the 1960s, the exchange rate at which Russia’s debts and credits were valued was based on the amount of gold in the rupee. In 1966, India decided to devalue the rupee in domestic and international markets after the economy went through a series of problems. Not surprisingly, Moscow wanted a revaluation of the agreement.
In 1971, global gold reserves became inadequate to support the system of fixed exchange rates based on the gold standard. The US devalued its currency by 8.5 per cent against gold by raising the price from $35 an ounce to $38 under the Smithsonian Agreement, and the G10—the world’s 10 largest economies—devalued their currencies against the dollar.
The devaluation of the British pound, to which the rupee was linked, eroded its value even more. Speculators and traders in foreign exchange markets pushed values down further and, in 1973, the system of fixed exchange rates collapsed, replaced by floating rates. Ten years after India devalued the rupee, India and the USSR still hadn’t agreed on an exchange rate.
Finally, in 1978, a Protocol set it at Rs 10, a rupee higher than the rupee-dollar rate. Even after India switched to a flexible exchange rate against a basket of 16 currencies, the rouble rate continued to be administered.
That said, we live in a vastly different situation today. “The value of both rupee and rouble are market determined now,” says Indranil Pan, Chief Economist at YES Bank. “A huge diversion of India’s trade to Russia on the basis of a new rupee-rouble agreement seems a little farfetched.” He points to the difference in economic sizes as measured by GDP. India’s economy is many times larger than Russia’s (see GDP Matters).
Discussions on the new agreement are taking place in rather tumultuous times. A research note written in March by State Bank of India’s Chief Economist Soumyakanti Ghosh and his team identifies a few key factors. On top of the list is the uncertainty created by the continuing conflict, which can weaken the rupee’s value. A second factor, once the conflict in Ukraine wanes, is the inflation-attacking actions taken by central banks, led by the US Federal Reserve.
Ghosh expects the conflict to ‘drag on’ slowly for now. Statements by Russian generals and other members of President Vladimir Putin’s cabinet appear to suggest the same thing. No side is blinking first—at least, not yet. “That said, I don’t think there will be any immediate impact of the rupee-rouble agreement on the rupee’s value in the forex market,” says Ghosh. “It’s probably too early to say anything specific.”
Waiting for Godot?
Parthasarathi Mukherjee, former head and founding member of the treasury at Axis Bank—he left Axis to become managing director at Lakshmi Vilas Bank in 2016—thinks that historically, the terms of the bilateral agreements have not favoured Indian interests. “The challenge will be to make it as evenly balanced as possible,” he says. “Again, there are also operational questions. Public sector banking mergers are reducing the banks, so how will the government pick one for implementing purposes?” Even as he acknowledges that UCO Bank did that when India bought oil from Iran before sanctions were extended to oil, he thinks the Russian case will be more than a little complex.
On his part, Sen believes that the government will have to take the long view, rather than the short one: on just facilitating payments for example. “It has to be a carefully weighed decision that takes a number of factors into account that we hadn’t in the past,” he says. However, Commerce Secretary B.V.R. Subrahmanyam has clarified that the government wasn’t planning to trade with Russia via a rupee-rouble mechanism in the wake of the Ukraine crisis. The government only wanted to make sure that exporters awaiting payment for goods sold before the conflict were paid, he had added.
“We also probably need alternatives to SWIFT,” Mukherjee says. “There are a few others like SFMS, or Structured Financial Messaging Solutions that we have been trying, but SWIFT has the first mover advantage and is favoured.”
Which raises another question that people have hinted at: is it time to sharply reduce the dollar’s dominance in global commodities’ contracts and as the unit of account and payment? There is a Chinese yuan oil contract, but there has been very little pickup thus far. Others might yet emerge.
In the mid-1960s, when India’s debt servicing and repayment obligations put the economy under severe stress, British and German officials considered accepting part of the payments in non-convertible rupees that they could use within India. They also believed that businessmen who feared losing India as a market for their products might consider accepting non-convertible rupees.
Official thinking in the West coalesced around political and ideological concerns; in 1962, some even considered a USSR-like arrangement that would sell India military hardware, accept payment in non-convertible rupees in part payment, and keep India aligned with the West. But nothing came of those ideas. Or history may have just replicated itself with different players, or even repeated itself.
The writer is a freelance journalist; He tweets at @shrisrinivas
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