Sep 27, 2012

Trade invoicing in INR: Some thoughts

Most of our trade is invoiced in Freely Convertible Currencies (FCC) such as Euro (around 8% of total), Pound (3%), Yen(0.5%) or USD ( 87%). In fact, to become eligible for benefits under our Foreign Trade Policy, one has to realize the export proceeds in FCC 'only', as per para 2.4 a of FTP (ignoring minor arrangements through Vostro/Nostro/ACU and Nepal/Bhutan trade)

The questions are: why do we have this practise? Is it good? What if we tweak it and allow people to inovice  and realize the money in INR and let them avail the benefits of FTP. And what determines the invoicing currency in international trade to start with? Will traders rush to invoice in INR if they are allowed to? And so on. 

We have this practice of invoicing/realizing in INR because our currency is not an international currency. Till we become fully convertible, it is not easy to be an international currency. Importers cannot (generally) ask the quote in INR as the exporters from abroad cannot hedge INR easily. Exporters from India don't invoice in INR as the realization has to be in FCC (ok, there are many other determinants, right from differential inflation rate of trading currencies, proportion of country's share in global trade, currency strength and depth of forex market, microeconomic choices of firm such as existence of substitutes in market, macroeconomic compulsions, Grassman's law, etc, which I won't get into, to keep the blog simple)

There is enough literature on what determines the currency of invoicing. You can read about it here, or if you you want to understand it through the example of Euro, you can see here in greater detail. One might add that a stable (low exchange rate fluctuations), low inflation, internationalized currency, is always a preferred choice for trade invoicing. 

However, I find that most of the studies on invoice currencies relate to FCCs. Our currency is not yet FCC, due to the last bit of capital controls that we still have on INR. So this issue presents unique challenges, as there are hardly any studies that are done for the transition effect of internationalization of a currency. Perhaps, Chinese RMB comes closer to our example, though they are ahead of us in internationalizing their currency. 

There was recently a circular doing rounds for feedback, which asked the view on allowing INR as the currency for international trade from India. That would mean, amendment of FEMA, and amendment of our FTP to accommodate this. There is no point in not amending FTP as it will skew the incentive away from INR in that case.

I feel it is a good step in right direction, if implemented  We have been cautious with captial account convertibility all these years, with good reason. I think, the Govt is now warming up to the idea of opening up. We are following Chinese in this. The initial steps might see us getting into various swap agreements with multiple trading partners with whom we can have INR/XXX arrangements. This will slowly make way for other steps and gradual transition into FCC, over a comfortable period of time.  For sure, we are living in interesting times.