Should the rupee trade with Russia be revived?

  • Blog Post Date20 June, 2016
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The issue of revival of the bilateral rupee-denominated trade between India and Russia is back on the table after a break of over 20 years. This column contends that while there is justification for India’s hesitancy in reviving this trade, the prevailing conditions are such that it makes eminent sense for both sides - provided appropriate precautions are taken.

Since the visit of Prime Minister Modi to Russia in 2014, and even more since President Putin’s visit to India in November 2015, the issue of revival of the bilateral rupee-denominated trade between India and Russia is back on the table after a break of over 20 years.1 This time, however, there is an interesting reversal of roles which makes the issue intriguing to say the least – Russia is pushing strongly for the deal, while India is dragging its feet. During the 20 odd years that the arrangement was in force earlier, the USSR (Union of Soviet Socialist Republics) was seen as the benefactor and India the beneficiary.

Indeed, it was widely believed, including at the highest level in India, that this arrangement was the Soviet version of bilateral aid, which reflected political imperatives rather than economic rationality. Clearly the Russians held the same view, and the arrangement was scrapped shortly after President Yeltsin came to power in Russia as a component of his transition strategy to a market-oriented economy.2 What then are the changes that have occurred in the intervening two decades which could have led to this reversal?

In a theoretical paper prepared by me for the Indian Planning Commission in the early 1990s,3I had argued that under certain conditions the rupee trade was in fact beneficial for the USSR, and that there was no need to necessarily impute any charitable motives to the arrangement. For the last 20 odd years, the paper has been a historical curiosum, but it appears to have gained salience again; not just for the India-Russia bilateral trade, but perhaps even on a wider canvas.

Conditions that make rupee trade beneficial for Russia

In the paper, there were two conditions, either of which by itself, made the rupee trade beneficial for the USSR.4 The first condition was fairly general in that it applied to rupee trade across all goods and services. It was simply that the rouble had to be less overvalued relative to a common ‘hard’ currency, say the dollar, than the rupee.5 Unfortunately, this condition cuts two ways in that if the arrangement was beneficial for the USSR, it was not so for India, and vice versa. During the time that the arrangement was in place, both the rouble and the rupee were grossly overvalued. However, the rouble was clearly vastly more overvalued than the rupee.6 Thus, the belief that India was an unambiguous gainer from the rupee trade was unquestionably true. On the other hand, the USSR appears to have been a loser, at least on this count, and thus the ‘trade as aid’ view appears to have been justified to some extent.

The situation has changed dramatically since then. Today, the rupee and the rouble are roughly at par vis-à-vis the dollar at around 67 each. In other words, during the intervening 25 years, the rouble has depreciated by more than 2,200% against the dollar as compared to 180% depreciation of the rupee. It is quite clear that the rouble is now undervalued, probably quite significantly.7 The rupee, on the other hand, continues to be overvalued despite persistent current account deficits, mainly on account of strong capital inflows.8 Consequently, the balance on this count has tilted decisively in favour of Russia, which would at least partly explain Russia’s eagerness and India’s reluctance to revive rupee trade.

The second condition under which the rupee arrangement was beneficial for the USSR is more complex, and depended upon the nature of the products exported by the USSR to India under the arrangement. It was shown that if the goods exported by USSR to India were such that both the international demand and supply were not very sensitive to price changes in the short-run, and if the USSR retained control over the quantities supplied to India, then the USSR unambiguously benefited if it calibrated its supply carefully. In international trade theory, this is referred to as the “Marshall-Lerner condition”, and provides the rationale for “optimal export taxes9. During the period under consideration, the main export from the USSR to India was crude petroleum (or oil), and there is no doubt that this condition was met. For most of this period, it may be recalled, the Organisation of Petroleum Exporting Countries (OPEC) was at its most effective and pretty much determined the world price of oil through restrictions on the output of its member countries. As a result, USSR had to restrict its oil output below its potential. The rupee trade with India allowed it to increase its oil output without violating its commitment to OPEC. Indeed, the USSR could actually reduce its supply to the world market, thereby raising the spot price even further. The benefit from both these effects to the USSR is obvious.

The situation is very different today. Although the demand for oil probably continues to be relatively price-insensitive, the same is not true for the supply. The shale-oil revolution has made the supply of oil far more flexible than ever before. On the face of it, therefore, it would appear that the Marshall-Lerner condition no longer obtains, and hence Russia may not reap the benefit that it got earlier from rupee trade. However, if a more strategic view is taken, it appears that the shale-oil threat becomes credible only when the price of oil goes above about US$80 per barrel. There is thus a fair range of oil prices over which an OPEC arrangement will be effective.10 Coordinated production cuts by the main oil producers are inevitable in the near future; in which case the argument in favour of the rupee arrangement again becomes valid for Russia.

What’s in it for India?

On both counts, therefore, Russia stands to gain from a revival of the rupee trade arrangement. What about India? There are two small pluses and one large minus. The first plus is that since the shadow price of the dollar continues to be higher than the official rate, any essential import that is switched from dollar payment to rupees is a gain. The second is that if the rupee is the medium of exchange with Russia, there is some seignorage to be made for India.11 The minus arises from the overvaluation of the rupee vis-à-vis the rouble, which encourages higher inessential imports from Russia by India as well as diversion of Indian exports from the world market to Russia. This negative, however, can be addressed through a suitably designed Indo-Russian agreement.

Designing a mutually beneficial Indo-Russian trade agreement

Indeed, the agreement that was in force earlier provides a good template with some minor tweaking. It may therefore be useful at this stage to briefly describe the rupee trade arrangement as it existed. The USSR contracted to sell to India a fixed volume of specified commodities (mainly oil) during any given year under a bilateral annual trade protocol.12 The price payable by India for this supply was the dollar rate prevailing in the international markets at the time the supplies were affected.13 These dollar values were converted to rupees at the prevailing rupee-dollar exchange rate and were credited to the Soviet account maintained by the Reserve Bank of India (RBI). The USSR would then allocate these rupee funds to Soviet trading organisations for purchase of goods from India. Since the rupee was not convertible, these funds could not be used for making purchases from third countries, but there were no restrictions on what could be imported from India.

This time around, Russia is likely to demand a more open regime, but India should resist this and continue with a restricted list of goods that can be imported from Russia under this arrangement. The import list will almost certainly contain all Russian products for which the Marshall-Lerner condition is met, or may potentially be met,14 but can also include other products which feature prominently in India’s import basket. The only question here is pricing of such products which do not have readily available international benchmarks. Given that the degree of misalignment of the rupee and rouble exchange rates at present is not particularly large, it may be left to the trading partners without much risk of damage.

On the Indian export side, there are two dangers that need to be protected against: the first is the diversion of Indian exports from the international market to Russia; and the second is re-exports from third countries through the rupee payment route. Under other circumstances, it may have been desirable to draw up a positive list of permissible exports, which could include all products which are not major exports from India and such export products for which excess capacities exist in the country. However, in view of the state of the global economy and the fact that Indian exports have registered negative growth for the past 18 months, such precautions are unnecessary and may even reduce the benefits from the arrangement.15 It should be sufficient to simply deny export benefits to all supplies made against rupee payment.16

All in all, therefore, while there is justification for India’s hesitancy in reviving the bilateral rupee trade with Russia, the prevailing conditions are such that it makes eminent sense for both sides, provided appropriate precautions are taken. There will no doubt be hard bargaining, but there is no reason to believe that a mutually beneficial deal cannot be struck; and the sooner, the better.


  1. A joint mechanism was set up in 2014 to go into the issue and to advise the governments accordingly. From all reports, it appears that there has been very little progress, if any.
  2. Another contributory factor in this decision could be that Russia was applying for membership to the International Monetary Fund (IMF), and bilateral payments are specifically barred by Article VIII of the IMF. In fact, Russia scrapped all bilateral payment arrangements, including those with the member countries of the Council for Mutual Economic Assistance (CMEA), the formal nomenclature for the Iron Curtain area.
  3. “Hard Goods and Soft Currencies: A Note on Bilateral Payment Arrangements”,
  4. These are referred to as the “sufficient” conditions.
  5. In technical terms, this means that the shadow premium on the dollar should be less for the rouble than for the rupee. In such a situation, there would be a switch in Indian exports from the rest of the world to USSR and an increase in Indian imports from USSR.
  6. In 1990, for instance, the official rouble-dollar exchange rate was 0.3, whereas the prevailing black-market rate was around 3.5 – an overvaluation of more than 1,000%, if the black-market rate is used as an indicator of the true value of the rouble. On the other hand, the black-market or the havala rate of the rupee vis-à-vis the dollar was at a premium of ‘only’ around 50% over the official exchange rate of Rs. 24 during the same period.
  7. Russia has been running large current account surpluses for some time now. Even with the crash in oil prices in 2015, the current account continues to be in surplus, possibly on account of the 45% depreciation of the rouble in 2015.
  8. With the corrections in the values of the two currencies over the years, the black-market rates for both are not as widely quoted as earlier, although the havala rate for the rupee is still available and is about 20% above the official rate.
  9. Technically, the requirement is that the sum of the absolute values of the elasticities of demand and supply be less than one.
  10. The issue facing OPEC will be how to move oil prices from around US$40 per barrel at present to somewhere near US$80.
  11. Seignorage is the benefit gained from the authority to print money.
  12. The products and the volumes were determined by the USSR.
  13. For each product, there was a specified international benchmark rate that was agreed upon.
  14. Three goods immediately come to mind: oil, natural gas and nitrogenous fertilisers; but there may be others as well.
  15. Accelerating growth in the country requires a revival in exports. If Russia can provide this, it should be welcomed.
  16. This provision existed in the earlier arrangement as well, and served the purpose quite effectively. See Sen, Pronab (1990), “Rupee-Rouble Exchange Rate”, Economic and Political Weekly, March.
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