India and the UAE have a deep-rooted relationship in terms of culture and trade, with the UAE being the first country to sign a Comprehensive Economic Partnership Agreement with India. In July 2023, both countries formalized an agreement to settle transactions in their local currencies – the rupee and the dirham, aiming to boost bilateral trade to $100 billion. The first deal under this currency exchange was an oil transaction, signaling the beginning of a new era in trade between the two nations.
India’s trade deficit with the UAE was $21.62 billion in 2022-23, comprising 8.2% of its total deficit. Despite this, bilateral trade between India and the UAE has been on the rise, increasing by 16% to $84.5 billion in the financial year 2022-23. This new mechanism of settling transactions in local currencies is expected to further enhance trade relations and reduce transaction costs for exporters from both countries.
The transaction mechanism involves exporters from the UAE receiving payment in Indian rupees and Indian exporters receiving proceeds in UAE dirhams, directed to their respective accounts in the other country. While the initial deals have mainly involved oil and a few other sectors, the potential for growth in various industries is substantial. The central banks of both countries are optimistic about an increase in settlements in local currencies, emphasizing the need to reduce dependence on the dollar.
The lack of active private sector involvement and awareness among small businesses are currently hindering the widespread adoption of this new settlement mechanism. However, as more companies and individuals become acquainted with the process, it is expected to gain momentum in the coming years. By reducing transaction costs and eliminating the need for foreign currency, the local currency settlement system aims to make exports more competitive and inclusive for small and medium enterprises.
The Indian rupee/UAE dirham settlement system has the potential to benefit various sectors such as tourism, services, and manufacturing. It could also aid in achieving the UAE’s goal of food security and developing the MSME sector by making trade more accessible to smaller players. This new mechanism is not de-dollarization but rather a way to reduce reliance on the dollar and insulate bilateral trade from geopolitical risks and currency fluctuations.
The cooperation between the central banks of India and the UAE to link payment platforms such as UPI and IPP will enhance cross-border transfers, making them faster, safer, and more cost-effective. This development could have a transformative impact in the long run, facilitating smoother transactions and further strengthening trade ties between the two nations. With the establishment of a flourishing forex market for the Indian rupee and UAE dirham, the potential for growth and cooperation in various sectors is immense.
