In today’s Finshots, we offer a simplified and crude explanation of how trade between two countries can bypass the US dollar and the implications of doing so

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The Story

The big news this week is that India may choose to buy crude oil from Russia at a massive discount.

Now, this shouldn’t be all that surprising. Russia has few trading partners at the moment and it’s having trouble monetising one of its biggest assets — oil. And without oil money, the Russian government would struggle to keep the economy afloat, let alone wage a protracted war against Ukraine. For India, this is an opportunity to reduce its import bill. At the moment, global oil prices are sky high and we’ll have to pay through the roof as we continue to import most of our oil from abroad. So if we could somehow figure out a way to trade with Russia and get that oil at a discount. It would be a win-win for everyone involved.

However, getting this done won't be easy. Especially since the US has effectively barred Russia from accessing dollar assets.

How does this matter you ask?

Well, it’s kind of a long story. But after the world war, the US emerged as the single largest economy. And as their influence grew, the dollar became ubiquitous. So much so that, India imports only 5% of our oil from the US and yet settles 85% of all oil transactions using the dollar. And this means all dollar transactions move through some bank in the US. Including transactions with Russia.

However, now that this isn’t possible anymore, Indians are exploring a Rupee-Ruble (Russian currency) deal to see if we could simply use our own currencies to conduct trade.

In principle, this should be easy. In reality, however, this can be extremely complicated.

Let us explain.

You can execute a simple rupee-ruble trade by having a Russian bank open an account in India and an Indian bank open an account in Russia. India will maintain a sizeable amount of rubles in its Russian bank account (by paying for it in Rupees) and Russia will do the same in India.

It’s actually a throwback to the 1950s when India struck up a chummy relationship with eastern European nations. And for many years, the erstwhile Soviet Union and India conducted trade using this simple arrangement.

But revisiting the relationship in the modern world has its own hurdles.

Firstly, we need to figure out the “value” of rupees and rubles.

You see, since most of the global trade is executed using dollars, currencies are valued against the dollar. We say things like, “Rupee has appreciated against the dollar. Ruble has depreciated against the dollar.” In fact, many currencies don’t even have a direct relationship with each other. Imagine having to calculate the value of the Indian rupee against the currencies of over 190 other countries every single nanosecond. It would be a nightmare! That’s where the dollar comes in as a reference. It makes life easier.

Anyway, the problem here is deciding the exchange rate. How many rupees do you need to shell out to get a Ruble? This will be the first hurdle we will have to clear if we are to engage with Russia, especially considering Ruble has tanked 30% against the dollar already.

Then there’s the problem of trade imbalance. If India imports a lot of oil from Russia, then Russia could end up with a boatload of Indian rupees in its account. That’s a problem because the Indian rupee isn’t like the dollar and it has limited use in international trade. So, if Russia wants to buy machines, China won’t accept payment in rupees. And what’s the use of money if you can’t use it anywhere? In fact, this surplus accumulation of rupees was one of the reasons why the trade agreement from the 1950s eventually collapsed.

Finally, there’s the fact that this engagement may invite sanctions too. If India offers Russia a way out, by trading using Rupees and Ruble, then the US may also come to target us.

So yes while it seems both countries are exploring the option, it might take a while before we see discounted oil hit India’s shores.

Until then...

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