PastForward is a deep research offering from ThePrint on issues from India’s modern history that continue to guide the present and determine the future. As William Faulkner famously said, “The past is never dead. It’s not even past.” Indians are now hungrier and curiouser to know what brought us to key issues of the day. Here is the link to the previous editions of PastForward on Indian history, Green Revolution, 1962 India-China war, J&K accession, caste census and Pokhran nuclear tests.
When it comes to oil, India and Russia have always found roundabout ways of helping each other.
Back at the height of the Cold War, the Soviet Union virtually subsidised India’s oil sector, supplying the oil India needed to Iraq, which in turn would supply India. Today, as the Russian war with Ukraine has frozen out most Western countries, India has found itself refining Russian oil for the rest of the world.
The Soviet nostalgia is still strong in India, which has always shared a deep friendship with Russia — creating circuitous, convoluted routes for both friendship and economic activity. More importantly, at the height of the Cold War, the Soviet Union had the Midas touch: it was providing liquid gold to India’s developing economy, and developing Indian industries like steel. At this current moment, India is an outlier on the global stage for engaging with Russian economic activity. It’s reminiscent of older times, which has brought back talk of the revival of an old Cold War relic: the rupee-rouble trade.
But the rupee is in trouble in Russia: the Russians have too much and don’t know what to do with it.
The mechanism of the rupee-rouble trade then seems to have been born out of both necessity and practicality. Critics such as veteran financial journalist AK Bhattacharya have labelled the system “highly flawed,” and dismissed the idea of resurrecting it in 2023 as “laughable.”
In fact, Russian Foreign Minister Sergey Lavrov went so far as to brand trading in rupees a “problem” for the country at the recent Shanghai Cooperation Organisation (SCO) ‘Council of Foreign Ministers’ meeting in Goa.
American and European sanctions on Russia following the outbreak of war in Ukraine have disrupted international trade — a large part of which is carried out using dollars. But Russia is an important trade partner for India, which is why the idea of the rupee-rouble trade is back on the table.
From the set-up of the Bhilai steel plant in 1959 to supplying defence equipment after the 1965 India-China war until its collapse in 1991, the USSR offered a generous hand to India — allowing it to trade in rupee, which meant that loans would be self-liquidated in export form to Russia. On the one hand, Russia was signalling stronger ties with a non-aligned country like India; on the other, a parched New Delhi was looking to boost its economy.
But this strange and cosy currency-deal created a world of quixotic incongruencies, skewed trade balance, and some absurd adventures. India’s near exclusivity of a strategic partnership with the Soviets led to the Indian government signing off on “unremunerative” export deals at “throwaway prices,” according to Bhattacharya.
“It was like a swap arrangement, we would end up paying rupees to the Soviets, thereby conserving a huge amount of forex,” said Nandan Unnikrishnan, a Distinguished Fellow at the Observer Research Foundation. “That evolved into the so-called rupee rouble trade arrangement.”
The rupee-rouble romance
This isn’t the first time things haven’t gone to plan. India and Russia have been here before, when the rupee-rouble trade unleashed economic havoc in the 1990s after decades of buildup.
It looked like an attractive deal for policymakers in the late 1970s, but a deep paradox lay at the core: the ruble was always overvalued — in 1978, the Rs 10 peg was a point above the rupee-dollar exchange rate. The overvaluation became larger and larger over the years, and India found that it was overpaying for imports while being in a trade deficit. And in the 1990s, after the dissolution of the Soviet Union, this was a problem.
The rupee-rouble romance had a rough ride. The story begins, as it usually does, with newly independent India looking for a shoulder to steady itself on. The erstwhile Soviet Union provided a necessary crutch — it served as a blueprint for India’s nascent economy. And over time, as political and cultural bonds strengthened, an economic opportunity presented itself: the rupee-rouble trade.
The rupee didn’t have as much value throughout the 1970s, 80s, and 90s — and going by Russian reluctance, still isn’t taken as seriously as a global currency. But India was still an important friend to the Soviet Union, and the Soviets were spending a lot of money in India.
And the kinds of goods being exchanged between India and Russia ranged from hard imports like oil and machinery to gems, jhumkas and jootis. India’s rice, tea, tobacco, jute, and pharmaceuticals were hot cakes in Moscow.
As much as Moscow and Delhi were joined at the hip, the exchange rate between the currencies of the two countries was a thorn in India’s side — what seemed like a fair trade would turn out to be an unequal exchange.
The genesis lies in the Indo-Soviet trade agreement, signed in the winter of 1953. It solidified transactions between the two countries in rupees.
But the then-RBI governor HVR Iyengar started ringing alarm bells as early as 1961.
He wrote to Nehru highlighting the risks associated with such an arrangement with the USSR. RBI officials claimed that they found evidence of “switch trading”, where Indian exports paid for with non-convertible rupees to other countries such as Poland, Yugoslavia, Czechoslovakia and Hungary were diverted or re-exported to hard currency countries. The unease extended to Russia too — the practice compromised the spirit of the bilateral currency agreements. India could also be a “free trade zone” for Russian imports — basically buying cheap what the other countries (the West) sold expensive. Russia could easily source from India some extremely attractive imports — one item in extreme demand was colour picture tubes and TV sets from South Korea.
But Nehru’s loyalty to the Soviets far exceeded such concerns. The former PM wrote a two-page, hand-written note to the finance ministry, brushing the worry aside and instructing it to ignore the former Governor’s views, saying “political compulsions far outweigh the economic considerations in this relationship”.
“It was a major area of concern. There were two ways of doing this (switch trading). One, these exports (India’s) would be used by the USSR and its allies. Two, the Soviet Union would meet its own import needs without spending dollars. It would use ‘India’s dollars’ to finance its imports,” says AK Bhattacharya, policy expert at Business Today. India would buy raw materials from hard currency countries such as Malaysia and Indonesia, and manufactured goods would be traded to the Soviet Union at cheap prices.
“Anyone who were to say bad things about the ruble-rupee trade was considered ‘anti-national’,” Bhattacharya adds amusedly. Everybody from the government to the bureaucratic machinery were tacit supporters of the trade.
The PM had drawn the fence up with Indian policymakers: the RBI was largely excluded from the policymaking side of this relationship. It was clear that this was more of a political handshake than an economic choice.
Supporters and Russophiles — from Nehru to Rajiv Gandhi — of the rupee-rouble romance believed that the exchange rate arrangement was a non-issue that didn’t have any operational value. And ten years later, the romance was only getting stronger — defence supplies from Moscow came in fast in the aftermath of the war with Pakistan in 1971.
Also read: 100 yrs of Soviet Union: Nehru-Indira era over, but idea of USSR still rules Indian mind
The sticky exchange rate
But 1971 was also an important year for the global currency market.
Once the Bretton Woods system collapsed and the US dollar became the new ‘gold standard’, the gold content of world currencies became a “fiction”, and exchange rates were left open to market adjustments. As a result, a gap emerged between exchange rates set by countries based on their respective official gold content and operational exchange rate. The Soviet Union used to arbitrarily fix its exchange rate with all other currencies to accommodate the exigencies of foreign trade.
Like the ruble, the rupee wasn’t a freely tradable currency — and things turned complex between Moscow and Delhi. While India asserted that the exchange rate be determined by the respective gold content of the two currencies, the USSR wanted to change it solely on the basis of the value of the rupee by averaging the cross rates of the major currencies in the international market with the Indian currency.
Having a third freely tradable currency as an intermediate between rupee and ruble didn’t seem like a good option to India — it would devalue the rupee against the ruble significantly.
After some back-and-forth, a protocol was signed on 25 November 1978, when the exchange rate was changed to Rs 10 per rouble.
It was determined on the basis of the exchange rates of a multi-currency basket having the US dollar, the pound sterling, the DM, and the yen as the major currencies. In this scenario, the rupee’s devaluation against the ruble was 20% compared to 1966 levels — whereas on the cross rates it would’ve been 40%. Repayment by India against past credits was finalised at the old rate with no extra liability.
Moreover, rupee and ruble were close to being sister currencies — both the currencies were primarily used as legal tender for transactions, exchange rates of these two currencies were fixed by the respective governments. Like with other economic exchanges, this led to black markets of sorts for rupees and rubles in both Russia and India — where one could buy each currency at variable prices. Moreover, after the collapse of the USSR, Russians offered rupees at highly discounted prices, sometimes even at 40% discounts, says Vinay Shukla, veteran journalist.
During the Mikhail Gorbachev years, the rouble was openly changing hands at a rate far below its formal exchange rate vis-a-vis the US dollar — in the black market, one dollar fetched more than ten, in some cases twenty. Moreover, India was exempted from the price advantage extended to the East European Warsaw Pact countries, Cuba and Vietnam. Despite all this, India depended on the USSR for defence supplies and oil — almost one-third of its annual imports. Since the exchange rate was one that had overstated the value of the rouble, consequently, India had to pay higher prices than the global level for Soviet goods.
On the other hand, the USSR purchased Indian commodities at much lower prices. This cropped up the demand for nullification of 1978 protocol and introduction of new formula for rupee-rouble exchange rate.
Assuming that the rates were at par in 1978, after 15 years, in 1993, the official exchange rate was fixed at Rs 23.5 — when it should have been fixed to Rs 14.16.
During the 1990s, while the Soviet rouble depreciated at a faster rate than the rupee, the RBI made an upward revision of the rupee-rouble exchange rate from Rs 21.86 to Rs 22.78 to a rouble in terms of 1978 protocol.
Also read: Hungry India, a nawabi US President, ‘Mexican blood’ — The real story of Green Revolution
A debt of gratitude
Things got more confusing in the summer of 1992. With the Rupee-Rouble trade arrangement on the way out following the collapse of the Soviet Union, the focus for Russia moved towards debt recovery.
India and Russia switched to trading in dollars, which meant taking a long, hard look at the foreign exchange rate. The rouble had devalued, which created a massive opportunity for India: India’s debt to Russia now dropped from Rs 38,000 crore to Rs 500 crore.
This should have solved India’s foreign debt problem: but India had a debt of gratitude to pay. The Soviet Union had invested huge sums of money in India, and was still an important supplier of arms. SS Anklesaria Aiyar remarked, “The Soviet Union is dead and gone, and you can not show gratitude to a corpse.”
But India could not afford to antagonise its regional big brother. While most countries played proverbial hardball with Russia, India’s commitment to repay its debt to Russia remains appreciated to this day, according to Unnikrishnan.
And so, an entirely new process of negotiating debt began. Multiple bilateral talks opened up between the two countries to settle on a new finance rate. Boris Yeltsin and then-Prime Minister Narasimha Rao once spent five hours locked in heated discussion. As part of the negotiations, Russia pushed for adhering to the 1978 protocol, which resulted in India committing to pay 63 per cent of the debt over a 12-year period, with the rest to be paid over 45 years, as noted by historian Jayanta Kumar Ray in his seminal work India’s Foreign Relations, 1947-2007.
However, Montek Singh Ahluwalia, then a secretary in the finance ministry under the Rao government, called the 1978 protocol ‘totally unsuitable and unrealistic’. “When the market reality is totally different, how can we agree to these terms?” he asked.
It wasn’t rupees or rouble that worked. Not even dollars. The currency that worked best in Moscow at the time was Marlboro. Or Parker pens, or any other symbol of American consumerism.
The possibility of resurrection
Russia’s in a tough spot. There is talk of reviving the rupee-rouble trade, but in a new format.
But those with a more critical view — like Unnikrishnan — believe that any contemporary revival of the rupee-rouble arrangement would be beset with fundamental problems due to the lack of Indian exports that Russia could spend its vast surplus of Indian rupees on, as alluded to by Russian Foreign Minister Sergey Lavrov at the recent SCO meet.
Unnikrishnan’s concerns over the viability of a modern rupee-rouble trade arrangement were echoed by Ritika Passi of the think tank Global Trade Observer, who outlined three key issues for India to keep in mind for any such formalised arrangement to be successful — managing exchange rate fluctuations, resolving trade basket complications, and dealing with uncertainties surrounding further sanctions.
“Whenever India and Russia have met, diversifying the trade basket has always been on the agenda, but that’s never quite happened…total trade volumes remain low, especially of Indian exports to Russia, which makes it far more difficult for these two countries to set a direct exchange rate between their currencies. India should prepare a precise list of what it can export against the items it is looking to import from Russia. But given uncertainty around further trade sanctions, I doubt we’ll see a solution anytime soon,” Passi explained.
Veteran financial journalist and editorial director of Business Standard AK Bhattacharya goes as far as labelling the idea of reviving the rupee-rouble trade as “laughable”. He emphasises that the previous arrangement was “highly flawed” and driven by geopolitical considerations. Bhattacharya acknowledges that certain Indian civilians, such as students on “concessional scholarships”, did benefit from the trade arrangement. However, he highlights the negative impact on India’s trade economy, including the strengthening of the black market that helped some Indian businessmen win big.
“Free trade is supposed to happen without any strings attached, but on many occasions the engineering council, for instance, was upset over the awarding of contracts [for relative peanuts], although exporters did not suffer beyond receiving this low price point…Until 1992, importers in India didn’t have freedom to finance imports without a letter of credit, which was easy to open for the Soviets. Quality and price were not a major concern, it was about helping the Soviets get rid of surplus rupees,” Bhattacharya told ThePrint.
Also read: Mikhail Gorbachev was a rare case of ‘revolution from above’
Time for exorcism?
The situation in 2023 is reminiscent of an editorial published exactly thirty years ago in 1993.
The issue of the exchange rate is a legacy of how trade policies between India and the USSR were shaped by geopolitical considerations and not hard economic logic, according to The Patriot. “Since this era and the special relationship it had brought about between the two countries was irreversibly gone, it was surely time to exorcise its ghost forever,” the newspaper declared.
It’s stormy skies ahead for Indian traders. The plan was to make rupee payments for Russian goods, deposited in vostro accounts in India that Russian exporters could then use to buy goods from India. But this has only led to billions of rupee payments lying in Russian accounts, which the Russians can’t use for anything else. But Russia is only India’s 36th largest export destination. And therein lies the rub: India has much more to buy from Russia than vice versa, and is therefore in a trade deficit.
Recent reportage underlines Russian reluctance to store rupees. But using another currency will throw up the same issues of how to convert money without impacting the exchange rate.
In fact, the Russians seem inclined towards a solution that would be uncomfortable for India: they prefer the Chinese yuan instead.
(Edited by Prashant)