Local Currency Settlement (LCS) Mechanism and Internationalisation of the Rupee

Local currency settlement means two countries pay each other for trade in their own currencies, instead of using a third currency like the US dollar. For example, an Indian importer buying goods from the UAE can pay in Indian rupees, and a UAE importer can pay in UAE dirhams. Internationalisation of the rupee is the bigger goal: making the rupee widely used by people and businesses outside India for trade, investment and savings.

Why does it exist?

Today, most world trade is priced and paid in US dollars. So an Indian importer first buys dollars, then pays the seller, who then converts the dollars into their own currency. This double conversion costs money at every step, like paying two commissions for one purchase. It also exposes businesses to swings in the dollar's value.

If India uses rupees directly, businesses save on conversion costs, face less currency risk and India needs fewer dollars for trade. It also makes trade less exposed to shocks in the dollar system, such as sanctions.

Where did it come from?

Some key steps:

• 11 July 2022: The Reserve Bank of India (RBI) set up a framework to invoice, pay and settle international trade in rupees. It works through Special Rupee Vostro Accounts (SRVAs).
• July 2023: An RBI Inter-Departmental Group headed by Executive Director R.S. Ratho gave a report on internationalising the rupee. It called internationalisation "a process rather than an event" and suggested short, medium and long-term steps, including working towards the rupee's inclusion in the IMF's Special Drawing Rights (SDR) basket.
• 15 July 2023: The RBI and the Central Bank of the UAE signed an MoU in Abu Dhabi to set up a Local Currency Settlement System (LCSS) for rupee and dirham trade. They also signed an MoU to link payment systems.
• The first deals followed quickly: a gold deal invoiced in rupees (25 kg of gold), and in August 2023, Indian Oil Corporation paid the Abu Dhabi National Oil Company (ADNOC) in rupees for one million barrels of crude oil.
• The RBI later signed similar local-currency MoUs with Indonesia (March 2024), the Maldives (November 2024) and Mauritius (March 2025).

How does a Vostro account work?

"Vostro" comes from Latin and means "yours". A vostro account is an account that a foreign bank keeps with an Indian bank, in rupees. Here is the flow, step by step:

1. An Indian bank opens a Special Rupee Vostro Account for a partner bank from the other country.
2. An Indian importer pays rupees into that account for goods it bought.
3. An Indian exporter selling to the same country can be paid out of the same rupee balance.
4. Surplus rupees left in the account can be invested in India.

Think of it like a shared "rupee wallet" that the foreign bank keeps in India. Money comes in from Indian buyers and goes out to Indian sellers, so no dollars are needed in between.

Recent easing by the RBI

• August 2025: Indian banks can open SRVAs without prior RBI approval. Surplus SRVA balances can be invested in central government securities, including Treasury Bills.
• October 2025: The RBI announced more steps. SRVA balances can also go into corporate bonds and commercial papers. Indian banks may lend in rupees to residents of Bhutan, Nepal and Sri Lanka. Financial Benchmarks India Ltd (FBIL) will develop reference rates for the rupee against more currencies.

The payment-system link with the UAE

Along with the LCSS, the two central banks agreed to link:

• India's Unified Payments Interface (UPI) with the UAE's Instant Payment Platform (IPP),
• India's RuPay card switch with the UAESWITCH, and
• India's messaging system SFMS (Structured Financial Messaging System) with the UAE's messaging system (to be explored).

These links make cross-border payments cheaper and faster, especially for the millions of Indians who send money home from the UAE.

Commonly confused concepts

• Vostro vs Nostro account: A vostro account is a foreign bank's account held in India, in rupees ("yours, with us"). A nostro account is an Indian bank's account held abroad, in foreign currency ("ours, with you").
• Local currency settlement vs currency swap: LCS is about paying for trade in local currencies. A currency swap is an agreement between two central banks to exchange currencies for a period, usually as a safety net in a crisis.
• Internationalisation vs full convertibility: Internationalisation means wider use of the rupee abroad. Full capital account convertibility means anyone can freely convert rupees to foreign currency for any investment purpose. India has current account convertibility (for trade and travel) since 1994, but only partial capital account convertibility.
• SDR basket: It has five currencies: the US dollar, euro, Chinese renminbi (yuan), Japanese yen and British pound. The rupee is not in it.

Issues, criticism and the way forward

• Rupee surplus problem: When India buys much more from a country than it sells to it, that country's banks pile up rupees they cannot fully use. Wider investment options for SRVA balances are meant to solve this.
• Thin forex market: There is no deep direct market between the rupee and many currencies, so conversion can be costly. The LCSS aims to build a rupee-dirham market.
• Capital controls: A currency becomes truly international only when foreigners can freely invest and exit. India keeps some controls to avoid sudden outflows, so progress is gradual.
• Way forward (from the RBI group and later measures): More rupee accounts for non-residents, more rupee-priced bonds abroad (Masala bonds), linking payment systems with more countries and more local-currency MoUs.

Concepts to Know

• Invoicing: Writing the price on the bill in a particular currency. Invoicing in rupees means the price is stated in rupees.
• Settlement: The final payment that closes a trade deal.
• Forex reserves: Foreign currency and gold that the RBI holds to pay for imports and to steady the rupee.
• Special Drawing Rights (SDR): An international reserve asset created by the IMF, valued using a basket of five major currencies.
• Masala bonds: Bonds issued outside India but priced in rupees, so the foreign investor, not the Indian borrower, carries the currency risk.