Chinmaya IAS Academy – Current Affairs Chinmaya IAS Academy – Current Affairs
Eye on Emirati flows
There are both risks and benefits in the rupee-dirham settlement system
The Reserve Bank of India (RBI) and the Central Bank of the UAE agreed on July 15 to establish a framework for enabling the use of the two countries’ local currencies for cross-border transactions.
The move towards permitting payments in the Indian rupee and the UAE dirham is aimed at promoting their use bilaterally, thus reducing the dependence on a third country’s currency such as the U.S. dollar as an intermediary for settling transactions.
As per the memorandum of understanding between the two central banks, all current account payments, including those involving the two countries’ exporters and importers, and certain “permitted” capital account transactions could be settled using either the rupee or the dirham.
The India-UAE local currency settlement system could also potentially serve as a precursor for other bilateral currency accords which, as an RBI Inter-Departmental Group suggested this month, could act as an important first step for the internationalisation of the rupee. While the idea is laudable, its actual success will hinge on the extent of adoption by businesses in both nations.
With the UAE’s trade surplus with India widening in the months since the bilateral Comprehensive Economic Partnership Agreement came into effect in May 2022, Emirati businesses need to see remunerative avenues to deploy the potential rupee flows should they opt to receive payments in the Indian currency.
One possibility, as the RBI indicated, was stepped up investment by UAE-based firms. The other possibility is of the UAE coming to serve as a currency entrepôt by enabling Indian businesses, dealing for instance with Russian suppliers, to use the West Asian country and dirham as a gateway for such transactions.
Given that the UAE’s predecessor entity, the Trucial States, used the Indian rupee and later the Gulf rupee as de facto currency until the mid-1960s, it may appear natural to reestablish currency ties. Still, in a rapidly evolving global environment, businesses will base their decisions on cold economic logic and policymakers must remain cognisant of the risks emanating from such moves even as they eye the opportunities.
De facto currency
De facto currency refers to a currency that is widely used and accepted in practice, even though it may not have an official legal status as the national currency. It is a currency that is commonly used for everyday transactions, despite not being the officially recognized medium of exchange.
The use of de facto currencies can arise due to various reasons, such as:
Dollarization: Dollarization occurs when a country unofficially adopts a foreign currency, typically the United States dollar, as its de facto currency. This can happen when the local currency loses credibility or stability, and people start using a more stable foreign currency for their transactions.
Parallel Currencies: In some situations, a country may have multiple currencies in circulation simultaneously. While one currency may be the official legal tender, another currency might be widely used and accepted in specific regions or communities, particularly in areas with economic or political instability.
Cryptocurrencies: Cryptocurrencies, such as Bitcoin, Ethereum, or others, can function as de facto currencies in certain contexts. They are not issued or regulated by any government but are used as a medium of exchange in online transactions and in some local economies.
Barter and Local Exchange Systems: In certain communities or regions, alternative systems of exchange, such as barter systems or local currencies, can operate as de facto currencies. These systems allow individuals to trade goods or services directly without using a national currency.
It’s important to note that de facto currencies may coexist with the official legal tender, but they lack the legal status and backing of the government or central bank. Their acceptance and value depend on the confidence and trust of the users in their usability and stability.
The use of de facto currencies can have both advantages and challenges. On one hand, they can provide stability and facilitate transactions in situations where the official currency is volatile or lacks credibility. On the other hand, they can complicate monetary policy, hinder economic integration, and create challenges for government regulation and oversight.
Bilateral Comprehensive Economic Partnership Agreement
The term “Comprehensive Economic Partnership Agreement” (CEPA) refers to a bilateral trade agreement between two countries or regions that aims to promote comprehensive economic cooperation and liberalize trade and investment between the parties involved. CEPA agreements go beyond traditional free trade agreements by addressing a broader range of issues, such as services, investment, intellectual property, and other areas of economic collaboration.
CEPAs are often negotiated between countries or regions seeking to deepen their economic integration and enhance their trade and investment relationship. These agreements typically involve the reduction or elimination of trade barriers, including tariffs and non-tariff barriers, and the facilitation of cross- border investments.
The specific provisions and scope of a CEPA can vary depending on the negotiating parties and their objectives. However, some common features of CEPA agreements include:
Trade in Goods: CEPAs aim to promote the liberalization of trade in goods by reducing or eliminating tariffs and other trade barriers. They may also include provisions on rules of origin, customs procedures, and technical barriers to trade.
Trade in Services: CEPAs often address trade in services, including sectors such as banking, telecommunications, insurance, and professional services. They aim to facilitate the movement of services providers, promote fair treatment, and enhance market access for service providers.
Investment: CEPAs typically include provisions to protect and promote foreign direct investment (FDI) between the signatory countries. These provisions may cover areas such as investment protection, investor-state dispute settlement mechanisms, and rules for the treatment of foreign investors.
Intellectual Property Rights: CEPAs often include provisions related to intellectual property rights (IPR), aiming to strengthen protection and enforcement of copyrights, trademarks, patents, and other forms of intellectual property. These provisions seek to promote innovation, technology transfer, and the development of knowledge-based industries.
Economic Cooperation: CEPAs may also include provisions for economic cooperation in areas such as customs cooperation, competition policy, government procurement, e-commerce, and environmental standards.
