RBI Allows Trade Settlement in Indian Rupee and Maldivian Rufiyaa
Why focus: GS3 Economy: Tests external sector, ACU mechanism & FEMA. Highly probable Statement 1/2 setup on cross-border INR settlement mechanics.
In News
What Happened
Why It Matters
Background
History & Context
What Changed
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Currency of Invoicing: BEFORE, trade was predominantly invoiced in freely convertible vehicle currencies like the US Dollar or routed via the ACU mechanism. NOW, exporters and importers can invoice their goods and services directly in Indian Rupees (INR) and Maldivian Rufiyaa (MVR).
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Exchange Rate Mechanism: BEFORE, exchange rates involved a double conversion (INR to USD, then USD to MVR), accumulating spread costs for banks. NOW, the exchange rate between the INR and MVR is determined directly by the market, eliminating the double conversion cost.
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Settlement Accounts: BEFORE, bilateral trade required standard Nostro/Vostro accounts denominated in hard currencies. NOW, Authorised Dealer (AD) banks can open Special Rupee Vostro Accounts (SRVAs) and corresponding MVR accounts under FEMA provisions to facilitate direct settlement.
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Foreign Exchange Risk: BEFORE, both Indian and Maldivian traders bore the risk of US Dollar fluctuations, known as third-party exchange rate risk. NOW, dealing directly in domestic currencies insulates traders from the volatility of the US Dollar.
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Scope of Permitted Transactions: BEFORE, cross-border capital account transactions were strictly regulated under standard hard currency norms requiring dollar reserves. NOW, the framework permits not only current account transactions but also mutually agreed 'permissible' capital account transactions in local currencies.
What Did NOT Change
The Asian Clearing Union (ACU) multilateral netting mechanism has not been dismantled or replaced. The new local currency settlement operates as a parallel, voluntary option, meaning businesses can still choose to route their trade through the traditional ACU system if they prefer.
Prelims Angle
NCERT Connection
Common Misconceptions
✗ The ACU has been replaced by the INR-MVR bilateral settlement mechanism.
✓ The ACU remains fully functional; the local currency settlement is an additional, voluntary option.
People often assume new bilateral frameworks supersede older multilateral agreements, but the RBI circular explicitly states the new mechanism operates 'in addition to the ACU mechanism, as hitherto'.
✗ All capital account transactions are now fully convertible between India and the Maldives.
✓ Only 'permissible' capital account transactions specifically agreed upon by both central banks are allowed.
Media headlines often claim 'all trade and financial transactions' are covered, leading students to confuse trade settlement flexibility with full capital account convertibility.
Practice Questions
Q1
How Many CorrectConsider the following statements regarding the local currency settlement framework between India and the Maldives: 1. It replaces the Asian Clearing Union (ACU) mechanism for trade between the two countries. 2. The framework allows the exchange rate between the INR and MVR to be determined directly by the market. 3. The RBI issued the directive under the provisions of the Foreign Exchange Management Act (FEMA), 1999. How many of the above statements are correct?
Q2
Match the FollowingMatch the following mechanisms/reports (List I) with their primary purpose/context (List II): List I: A. Special Rupee Vostro Account (SRVA) B. Asian Clearing Union (ACU) C. Inter-Departmental Group (IDG) Report 2023 D. Memorandum of Understanding (Nov 2024) List II: 1. Multilateral netting arrangement for intra-regional transactions 2. Established the framework for INR-MVR bilateral trade settlement 3. Provided a roadmap for the internationalisation of the Indian Rupee 4. An account held by a domestic bank for a foreign bank to settle INR trades Select the correct code:
Q3
Assertion & ReasonAssertion (A): The local currency settlement between India and the Maldives helps mitigate the risk of exchange rate volatility for traders in both countries. Reason (R): The framework eliminates the need to use a third-party vehicle currency like the US Dollar for invoicing and settling bilateral trade. Select the correct answer: