India and the UAE this week began settling bilateral deals using local currencies as part of an agreement signed earlier this year, with the new system expected to help reduce transaction costs and boost cross-border trade.
The first crude oil transaction under the local currency settlement (LCS) system took place on Monday between Adnoc and the Indian Oil Corporation, according to the Indian embassy in the UAE.
The transaction involved the sale of about a million barrels of crude oil, with Indian rupees and dirhams used, it said.
The move is significant since energy accounts for a major part of trade between India and the UAE.
Last year, petroleum products worth $35.1 billion were traded between the two countries, accounting for 41.4 per cent of total bilateral trade, according to the embassy.
The UAE is the fourth-largest source of crude oil and the second-largest source of liquefied natural gas and liquefied petroleum gas for India.
Under the agreement, Adnoc Gas will supply up to 1.2 million metric tonnes a year of liquefied natural gas to the South Asian country’s largest refiner.
The latest crude deal is the second major transaction under the LCS, with the first involving the sale of 25kg of gold from a leading UAE gold exporter to a buyer in India, valued at about 128.4 million Indian rupees ($1.54 million), the embassy said.
The LCS mechanism was established under a preliminary agreement to establish a framework mechanism for using local currencies for cross-border transactions signed in Abu Dhabi on July 15 in the presence of President Sheikh Mohamed and Indian Prime Minister Narendra Modi.
The framework aims to promote the use of both national currencies in cross-border transactions, the UAE Central Bank said at the time.
It will also seek to “streamline payment services in both countries, benefitting their respective populations, through the linkage of their instant payment platforms, local payment card systems, and financial messaging systems”.
“By establishing a framework that promotes the use of the two national currencies in commercial transactions, CBUAE and RBI [Reserve Bank of India] aim to develop the foreign exchange market, facilitate bilateral trade, encourage direct investment and facilitate financial transfers,” the regulator said.
The mechanism will enable consumers to easily gain access to payment services available in each country and support in strengthening relations and economic partnership between the two countries, UAE Central Bank Governor Khaled Balama said at the time.
Vijay Valecha, chief investment officer at Century Financial, said the inception of local currency settlement “marks a positive progression that stands to benefit both businesses and consumers”.
“Businesses will shed the weight of substantial currency conversion fees, leading to significant savings, especially beneficial for smaller enterprises,” he said.
“Also, real-time transaction processing will replace the customary multi-day delays associated with settling in US dollars, thereby enhancing cash-flow management and bolstering working capital,” he said.
Settling in local currencies will also provide businesses with a transparent view of settlement sums, thus reducing uncertainty and fostering strategic planning, Mr Valecha said.
For consumers, the move is likely to translate into lower prices for imported goods and services, as businesses will no longer need to pass on currency conversion costs, he said.
“It will help consumers save time, and money, and minimise currency risk. Additionally, a UAE-based company could pay Indian workers in rupees, streamlining payroll processes and enhancing convenience for employees.”
The UAE and India have been focusing heavily on improving ties since the signing of a Comprehensive Economic Partnership Agreement last year.
Since the Cepa between the UAE and India was put into effect, “we have witnessed real momentum in bilateral non-oil trade, which is keeping us on course to reach our target of $100 billion by 2030”, Dr Thani Al Zeyoudi, UAE Minister of Foreign Trade, said at the time.
“But this was always more than just a trade deal, and the increased investment flows, joint ventures and deeper market penetration underline the real potential of the agreement.”
The LCS agreement with the UAE is India’s first and is expected to reduce transaction costs and time, and increase reliance on local currencies, the embassy said this week.
“This will further add to the preferential terms accruing from Cepa. Traders can choose the payment currency based on mutual agreement,” it said.
The surplus balance in local currencies can also be used for investing in local currency assets such as corporate bonds, government securities and equity markets.
“LCS is likely to have a transformational impact not only on the bilateral economic relationship but in larger economic engagements across the world,” the embassy said.