Date : 20/07/2023

Relevance: GS Paper 2: Bilateral relations

Keywords: Currency Settlement System, Remittance, UPI, Gulf Cooperation Council

Context-

• During Prime Minister Narendra Modi's recent visit to the United Arab Emirates (UAE), the Reserve Bank of India (RBI) and the Central Bank of the UAE signed two crucial Memoranda of Understanding (MoUs) aimed at bolstering economic ties between the two nations. These agreements seek to promote cross-border trade in local currencies and enhance payment systems' efficiency, with the potential to significantly impact trade volume, remittance flows, and financial inclusivity.

Local Currency Settlement System (LCSS)

The first MoU focuses on establishing a Local Currency Settlement System (LCSS) to facilitate transactions between the Indian rupee (INR) and the UAE dirham (AED). The system covers all current and permitted capital account transactions, providing a robust framework for exporters and importers to conduct trade in their respective domestic currencies.

Benefits of LCSS Implementation:

• Mitigating Exchange Rate Risks: By denominating export contracts and invoices in local currencies, exchange rate risks associated with using a third currency as a standard are reduced, enabling exporters to offer more competitive pricing.
• Moreover, it could also lead to enhanced avenues for cooperation among the banking systems of the two countries, thereby contributing to the expansion of trade and economic activity for both. The major items of export from India to the UAE include mineral fuels, mineral oils, and products, bituminous substances, and mineral waxes, followed by pearls, precious stones and metals, electrical machinery, and equipment, among other things. The major items imported by India are petroleum crude and petroleum-related products. India-UAE trade rose to $85 billion in 2022. Furthermore, the UAE was India’s third-largest trading partner and second-largest export destination in FY2022-23. Conversely, India was the UAE’s second-largest trading partner.
• Strengthening INR-AED Exchange Market: The promotion of local currencies supports the development of the INR-AED foreign exchange market, enhancing liquidity and facilitating smoother cross-border transactions.
• Boosting Investments and Remittances: The LCSS is expected to promote investments and remittances between India and the UAE. It enables investors to transact in their domestic currencies, thereby fostering increased cross-border investments. Additionally, remittances from the large Indian diaspora residing in the UAE will become more streamlined, contributing to economic growth in both countries.
• Optimizing Transaction Costs: With streamlined transaction costs and reduced settlement time, the LCSS will make cross-border transactions, including remittances, more efficient and cost-effective.

Linking Payment Systems: Integration of UPI and IPP for Efficient Fund Transfers:

• The second MoU focuses on linking India's Unified Payments Interface (UPI) with the UAE's Instant Payment Platform (IPP). Additionally, the agreement includes the interlinking of card switches - RuPay switch and UAESWITCH - to facilitate seamless communication and transactions between different payment service providers.

Advantages of UPI-IPP and Card Switch Linkage:

• Fast, Convenient, and Safe Cross-Border Fund Transfers: The integration of UPI and IPP allows users in both India and the UAE to conduct fast, convenient, and secure cross-border fund transfers. This feature will foster economic cooperation and improve the ease of doing business between the two nations.
• Enhanced Remittance Flows: High transaction costs and exchange rate margins often burden remittances, particularly for low-wage earners. The UPI-IPP linkage addresses these challenges, making remittance flows more efficient and affordable for migrant workers.
• Expanding Payment Options and Cooperation: The interlinking of payment systems encourages cooperation between the banking systems of India and the UAE, fostering stronger economic ties and increasing trade and economic activity.
• Inclusivity for Non-Resident Indians (NRIs): The integration of non-resident accounts with international numbers into the UPI ecosystem promotes financial inclusivity. NRIs, including those residing in the UAE, can actively participate in India's digital payment system, enhancing cross-border financial integration.

Other recent Initiatives and Remittance Trends:

• Collaboration with Singapore's PayNow: In March, the National Payments Corporation of India (NPCI) collaborated with Singapore's PayNow to facilitate cross-border real-time money transfers. This strategic partnership aimed to make remittances more efficient and cost-effective. Officials at the Monetary Authority of Singapore (MAS) noted that this collaboration would result in remittances becoming 10% cheaper, benefiting both Indian migrants in Singapore and their families back in India.
• Non-Resident Accounts Onboarding in UPI Ecosystem: In January, the NPCI allowed non-resident accounts with international numbers from 10 countries, including Singapore, Australia, Canada, Oman, Qatar, the U.S., Saudi Arabia, the UAE, the U.K, and Hong Kong, to be onboarded into the UPI ecosystem. This move expanded financial inclusivity and empowered non-resident Indians to actively participate in India's digital payment system.

Remittance Trends and World Bank's Observation:

• The 2023 Migration and Development Brief by the World Bank highlighted significant trends in India's remittance inflows. In 2022, India experienced a substantial 24.4% increase in remittances, reaching a total of $111 billion, indicating the continued financial support from the Indian diaspora abroad to their families in India. This amount represented 3.3% of India's Gross Domestic Product (GDP), underscoring the significance of remittances in the country's economy.
• Furthermore, the report noted that remittance inflows from Gulf Cooperation Council (GCC) countries, which contribute approximately 28% of India's total remittances, also witnessed a surge in 2022. This growth was attributed to factors such as high energy prices, which favored the employment and incomes of less-skilled Indian migrants in GCC countries. Additionally, the GCC governments' special measures to curb food price inflation further supported migrants' remitting potential, enhancing the flow of remittances to India.
• The report highlighted that about 36% of the total remittances were attributed to high-skilled and largely high-tech Indian migrants in countries like the United States, the United Kingdom, and Singapore. This indicates the significant contribution of skilled Indian professionals working abroad to India's remittance inflows.

Conclusion:

The India-UAE trade deal, facilitated by the RBI and the Central Bank of the UAE through the signing of two crucial MoUs, holds immense potential for strengthening economic ties and promoting financial inclusivity. The establishment of the LCSS will encourage the use of local currencies in cross-border transactions, mitigating exchange rate risks and boosting investments and remittances. Simultaneously, the interlinking of payment systems will enhance remittance flows and ease fund transfers between India and the UAE, benefiting both nations' economies. These strategic agreements mark a significant step towards fostering economic growth, cooperation, and prosperity between India and the UAE.

Source: The Hindu