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India and Bangladesh have jointly launched a settlement scheme, enabling trade transactions between the two countries to be settled in Indian rupees.

The move comes as Bangladesh, an import-dependent nation, grapples with depleting US dollar reserves, while India endeavours to enhance the global influence of its currency, particularly in the wake of geopolitical shifts.

The initiative was set into motion on July 11, with ICICI Bank becoming the first financial institution to issue a letter of credit (LC) in rupees for a shipment of goods from Bangladesh into India, presenting the LC to beneficiary, Sonali Bank.

Both countries’ central banks have selected two lenders each to facilitate the rollout of the settlement scheme: India’s ICICI and State Bank of India and Bangladesh’s Sonali Bank and Eastern Bank.

Under the agreement, Sonali Bank and Eastern Bank have opened rupee-denominated nostro accounts with the two Indian lenders.

An ICICI spokesperson tells GTR the scheme will support trade in both directions, although it will initially prioritise exports to India, allowing Bangladeshi banks to build up their rupee reserves. Eventually, “once Bangladesh has adequate reserves, it can be expected that they will also initiate imports in Indian rupees”, they say.

For Bangladesh, the scheme is the latest attempt by policymakers to address the decline in the country’s US dollar reserves since the outbreak of war in Ukraine, which drove up prices for essential imports, such as food, fuel and fertiliser.

In response, Bangladesh’s central bank last year took a number of measures, such as allowing domestic lenders to maintain accounts in China’s currency for overseas trade payments and introducing rules discouraging non-essential imports, while increasing oversight of LC transactions worth over US$3mn.

Nevertheless, the country’s gross foreign exchange reserves dropped for 15 months straight between February 2022 and May 2023, declining from US$45bn to just under US$30bn, according to central bank data.

This drop in reserves has severely impacted Bangladeshi importers, who have faced challenges in opening LCs. In January, local media reported that ships carrying goods to Meghna Group Industries, a Bangladeshi conglomerate with US$1.2bn in revenues, had been held up in Chattogram port for weeks as the firm’s bank had been unable to fulfil LC payments to the foreign supplier, due to a lack of dollars.

Zaidi Sattar, chairman of Dhaka-based nonprofit the Policy Research Institute of Bangladesh, tells GTR that the new initiative is a “positive development” and should partly ease US dollar constraints in the banking system.

However, he also notes that the impact of the scheme may be limited, given its reported cap of US$2bn, which is only a fraction of the total value of India’s total exports to Bangladesh. UN Comtrade data show India exported US$14bn to Bangladesh in 2021.

For India, the rupee initiative aligns with its ongoing efforts to increase the influence of its currency in global trade. Recently, the Reserve Bank of India (RBI) signed an agreement with the UAE to settle trade in rupees, further solidifying its position in international trade settlements.

As reported by Reuters, an official with knowledge of the details of the agreement said India could make its first rupee payment for UAE oil to Abu Dhabi National Oil Company.

The rupee initiative is sector-agnostic and will benefit various types of transactions, providing advantages to both Indian import and export companies as well, the ICICI spokesperson tells GTR. “The new mechanism is expected to bring quicker settlement of transactions, greater price transparency and reduced cost of transactions,” they say.

Last July, the RBI introduced its system for international trade settlements in rupees, using vostro accounts, a move which analysts said would help facilitate trade with sanctioned states, such as Russia.