India is one of the largest trading partners of Bangladesh. The existence of different tariffs, non-tariff and anti-dumping barriers in India, however, mean that our exports to India are comparatively low in comparison to our import.
India has enjoyed an enormous trade surplus with us for many years now. According to the Export Promotion Bureau data, in FY19-20, our export was $1.26 BN against $8.2 BN import, FY20-21, export was $1.09 BN against $9.69 import and in FY 21-22, it was just $1.8 BN export against record import of $14.58 from India.
Accordingly, the trade deficit of Bangladesh with India has increased from 19% to 33% in the fiscal year 20-21.
Until now, we could manage the situation as we had a strong foreign currency reserve. But, due to the Covid-19 pandemic and Russia-Ukraine war, energy prices have become higher, destabilising the global supply chain and the commodity market. As a result, the cost of imported goods has increased. And the price hikes continue with a hike of dollar price. Import has become costlier, which has started depleting our foreign currency reserve, which fell from $42 BN in December 2021 to $39 BN this June 2022, as per Bangladesh Bank data.
To lessen dollar centric inflationary pressure, many countries of the world are looking at local currency-based bilateral trade as an alternative. On July 11, 2022, the Reserve Bank of India issued a circular (RBI/2022-2023/90) on International Trade Settlement in Indian Rupees (INR) with their partner trading countries.
Trade in INR as an alternative
Nowadays, countries around the world are trying to bypass the dollar-based trade settlement system to avoid the inflationary pressure of a stronger US Dollar. Few countries avoid it to maintain bilateral trade with sanctioned countries like Russia and Iran.
In Bangladesh, we are seeing that the Taka is becoming weaker every day against the US dollar and the same is happening to the Indian rupee (INR). To avoid the spillover inflation of a strong dollar against weak Taka or INR, maybe one of the probable solutions is carrying out bilateral trade in rupees with India. After proposing this back in 2013, this is the second time India has expressed its interest again to trade with Bangladesh in rupees.
How does the INR trade settlement work?
Under this mechanism Bangladeshi banks will open a Nostro account in India with any Indian bank to settle our trade transactions in INR. From an Indian perspective, it is a special INR Vostro account to them. Similarly, India will open a Nostro account in Bangladesh with any Bangladeshi bank for settling their trade transactions with us. It is a Vostro account for us.
AD (Authorised Dealer) bank of India will open a special INR Vostro account for Bangladeshi banks after getting approval from the Reserve Bank of India with details of the arrangement. Export earnings will be credited and import payments will be debited from respective countries' Vostro accounts.
For example, for Bangladeshi exporters, export proceeds will be credited to a special INR Vostro account against the invoices for the supply of goods or services to Indian importers. All export and import under this mechanism may be denominated and invoiced in INR.
Bilateral export-import payment will be conducted on the "matching principle". It means export will be settled by import of the same buyer and seller of the countries. "Set-off" of export receivables against import payables in respect of the same overseas buyer and seller with the facility to make or receive payment of the balance of export or import payables, if any, will be settled under this mechanism.
Countries enjoying surplus trade balance can use the surplus for permissible capital and current account transactions, per mutual bilateral agreements like payment for projects and investment, export / import advance flow management, or investment in govt treasury bills and govt securities.
Finally, after a period of time, the surplus country will repatriate principal plus interest to their home country in the US dollar or any international reserve currency (SDR).
Challenges for Bangladesh under this mechanism
To start with, we can't import first because of not having any INR in our special rupee Vostro account to make import payments. So, we have to export to India first to get Indian rupee in our Vostro account for import payments.
Though a large number of Indian people are working in Bangladesh and repatriate dollars from Bangladesh every year, both legally and illegally, the Indian government and their embassy does not issue any official work permit to Bangladeshi people to work in their labour market in skilled or less skilled work. So, except for formal export, we don't have any means of rupee earning for making import payments.
Therefore, only clients with matching export and import amounts with India can actually use this trading mechanism. It means the size of export receivables should be approximately the same as import payables. In reality, there is no client who has close to equal export and import. Actually, Bangladesh is in a trade deficit position with India. So matching or equal trade is impossible.
India will also never allow any negative balance in our special INR Vostro account maintained with Indian banks. It means Bangladesh cannot pay higher import bills than our export earnings. But if we can take any credit lines, the issue will be different.
If we have any surplus balance in our special Vostro account in India, India may give us investment opportunities, but Bangladesh doesn't offer such an investment facility right now. Bangladesh Bank could allow investment facility to India's surplus fund in our treasury bill and bond or government securities, or anything else, in the near future, through any bilateral agreement. However, while repatriating the fund they will take it back in US dollars, which can deplete our foreign currency reserve at the time of repatriation with principal plus interest. That will be very expensive compared to direct foreign currency borrowing and indeed will create more pressure on the country's forex reserve.
When India receives export proceeds in Taka in their Vostro account in Bangladesh, and if Taka becomes weaker against the US dollar, India will get less US dollar at the time of repatriation. That means the weaker the Taka, the less lucrative this trading mechanism to India. So, on bad days no one will come to support us.
Both Bangladesh and India are suffering from local currency devaluation against a stronger US Dollar, which may cause double exchange risk loss for Bangladesh. Like, when the Rupee becomes stronger than Taka, we will be the first-time loser. Later, India will repatriate the principal with interest in the US dollar (surplus amount) and if the dollar becomes more robust against Taka a second time, we will be a loser again in the same transaction.
Nonetheless, to make this trade settlement mechanism effective, our AD banks must search and match both exporters and importers of Indian goods to maintain matching principles under this system. To do this, all the banks can make a database of Indian exporters and importers, matching by communication and other arrangements, which seems very complex. Service export can be compared with goods if available goods export is not found for matching import. But from India, our service export or remittance income is almost zero. Besides, when the rupee is exchanged against Taka, the rupee will act as a dominant currency while invoicing and determining the exchange rate.
There are arguments like this mechanism will lessen overdependence on the US dollar, which helps to reduce dollar-based inflationary pressure for a while. Our currency will be appreciated abroad and the surplus amount of trade will be invested inside Bangladesh by foreign banks. But final repatriation (principal and interest) will be in US dollars, which will go from our foreign currency reserve. It will make our reserves worse.
Considering everything, such a trade settlement mechanism is suited only for trade surplus nations like India. We are a trade deficit country and don't have enough matching export-import between the same buyer and seller.
Salim Ahmed is a banker and analyst
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.