Trick or treat? That's the feeling bilateral pacts with India's first external trading partner, Russia, often leaves one with.
Historically, Indo-Soviet trade has been driven by political imperatives rather than economic rationality, which critics term as a sell-out of India's interests. There were at least two decisive moments when India had the chance to correct the exchange rate disparity, but couldn't. Now, with rouble knocked out of trading platforms and put under strict capital controls, it's finally rupee's moment to be bossy.
Helping the Indian currency is the country's changed position from a debtor to donor, after India extended a $1-billion soft loan to Russia in 2019. This period also marked the rise of rupee-rouble trade, and not the ongoing Russia-Ukraine war. Also giving an edge is India's GDP at over $3 trillion, which is twice that of Russia's. Whether India uses the opportunity for economic or diplomatic gains will be keenly watched.
It all began in 1953, when the Soviet Union helped India set up her first steel plant at Bhilai, defying western countries' unwillingness to support India's industrial growth. It was historic because, for the first time in the history of international trade, a developed nation agreed to open trade with an underdeveloped country in local currency. All loans were repaid with the export of goods invoiced in rupees. Even after the 1965 Indo-Pak war, the Soviet Union, unlike the US and Britain, supplied defence equipment not as aid but on long-term rupee-denominated loans.
During 1950s and 1960s, India entered multiple bilateral trade deals, some of which evoked concerns of switch trade or shunting -- diversion by socialist countries to world markets of imports from India paid for in rupees. An alarmed HVR Iyengar, then RBI Governor, wrote to Prime Minister Jawaharlal Nehru alerting him to the limited benefits and dangers of such deals. But Nehru brushed them aside. In a two-page handwritten note, he instructed the finance ministry to ignore the Governor's views and declared that 'political compulsions far outweighteed economic considerations in this relationship.'
But trouble started when the rouble-dollar exchange rate began changing after the dollar lost its gold moorings in 1971. Neither the rupee nor the rouble were freely traded on exchange markets then and all commercial transactions were made at Rs 8.333 to a rouble, determined based on the respective gold content of the two currencies. But the Soviet Union wanted to fix rouble-rupee rate based on select basket of currencies of its choice, which India resisted to avoid rupee devaluation. After a long tussle, the 1978 protocol was signed pegging the rouble-rupee rate to an unknown multi-currency basket. The exchange rate changed to Rs 10 per rouble and remained market-driven.
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Trade too grew multi-fold, so much that the Indira Gandhi government refused to heed the threats by the US. In 1981, India approached the IMF for a $5-billion loan, but the US threw a monkey wrench, demanding forthright criticism and public condemnation of the Soviet invasion on Afghanistan. India needed the Soviets, not just for key defence supplies, but the rupee-rouble trade aggregated 16% of India's total trade. So, Ms Gandhi simply responded with an intent to increase India's dependence on Comecon, a Soviet-led economic grouping including socialist economies and its allies. The IMF loan request was granted without further hiccups.
But a decade later, exchange rate became a sore point once again following the the Soviet Union's disintegration in 1991. As rouble started depreciating, in grey market, one dollar fetched more than Rs 10-20. It fell faster than the rupee and by the end of 1991, the tourist rate for one rouble equalled Rs 43-48, while for commercial transactions, it was Rs 30. India wanted to nullify the 1978 protocol as it was paying more for imports, but earning less via exports. By then, the value of rouble was quoting at 190-300 roubles to a dollar and the market value of a rouble via the dollar route worked out to one fourth of a rupee.
Then there was the issue of black market. The rupees were smuggled to West Asia and converted into dollars through hawala transactions. The dollars were then taken back to Russia and the rates were changing rapidly. The other issue was switch trading. Many Russian companies obtained expensive consumer goods and technology from the west at cheap rates via India. Some Indian companies purchased either technology or components from the west in hard currency and then assembled and sold it to the Soviet Union in rupees, draining Indian forex.
By 1992, Russia was on the IMF's doorstep seeking membership and agreed for a new rouble rate in lieu of aid worth $24 billion. On the first day of the new exchange rate regime, one dollar equalled 125.26 roubles. By this measure, rouble's value plunged to 25 paise, taking the value of India's debt down from Rs 38,000 crore to Rs 500 crore! India's Soviet debt obligations would have ended at once, but Russia insisted on maintaining the 1978 protocol regardless of its new exchange rate. In return, India demanded writting off some debt, but couldn't succeed. It sought a 45-50% correction in exchange rate taking the value of debt to Rs 17,000 crore, but Russia favoured a 20% correction.
Eventually, in January 1993, after a five-hour discussion between President Boris Yeltsin and Prime Minister PV Narasimha Rao, an exchange rate Rs 19.90 per rouble, closer to the Russian offer, was agreed upon taking the value of debt to Rs 24,250 crore.
Like the 1978 protocol, which was signed after a prolonged tussle of six years, the 1993 protocol too took six years to materialize. But both were criticised for taking into account only rupee devaluation, and assuming rouble to be free from exchange rate fluctuations. For instance, when the 1993 deal was signed, one dollar was fetching 558 roubles, but commanded only 30 rupees. On this basis, India's debt was valued at Rs 1,877.63 crore, but was settled for Rs 24,250 crore. The government, however, dismissed critics citing the political-vs-economic rationality logic.
Now, India is on the other side, issuing credit. Moreover, if in 2019 over half of the Indo-Russian trade serviced in dollars, by 2021, it fell to 38.3%. On the other hand, 53.4% of all payments were in roubles. While it's true that India's oil imports from Russia shot up from 0.2% to 10% in less than six months, but the implication here is not solely due to discounted crude prices. India needs this to prop up the rupee, which is at its lowest level against the dollar at Rs 80. That translates to a valuation difference of 80-1, whereas the GDP value difference is only 10-1. Lastly, the rupee-rouble trade helps RBI to conserve 16.38% of forex currency use in Indian trade. This comes in handy during foreign capital flight.