The Indian Economy Blog

September 24, 2007

Russia’s Rouble Advantage

Filed under: Business,Economic History,Trade — Pragmatic @ 10:13 pm

Tajikistan, under the Russian influence, has repudiated the Indian proposal for an air base in the strategically important Central Asian republic. The Russians have pressed the Tajikis for this eviction to pressurise the Indians into favouring the Russians while signing the lucrative multi-billion dollar defence deals. The Russian insistence comes as no surprise as over three-quarters of Russian defence exports are to India and China.

Despite India’s oft-proclaimed Non-aligned status in the Cold war era, India and the erstwhile Soviet Union (now Russia) have a history of supporting each other in areas of strategic congruence. After Indian independence, Stalinist Russia considered India as a “tool of Anglo-American imperialism”. Things changed dramatically after Stalin’s death in 1953 and till 1971, the trade between India and USSR was based on the Rupee – Rouble rate determined by the Gold exchange standard. In 1971, the abandonment of the global gold exchange led to a devaluation of the Rupee against other western currencies (but not gold), thereby putting the Rouble at a disadvantage. In 1971, the exchange mechanism was linked to a basket of currencies and

the economic and defence cooperation between the Soviet Union and India was financed on the basis of state credits granted to India on favourable terms. The currency of the credits was an artificial monetary unit – Rouble with base value equal to 10 Rupees that was subject to adjustment proceeding from changes in the Rupee value of a special basket of 16 currencies (the basket of the SDR unit as of 1978). This artificial “credit Rouble” and the mechanism of its rate determination were quite different from the domestic Rouble being the non-convertible domestic currency of the Soviet Union.[Link]

The trade between the two countries increased from less than 2 Crores in 1953 to about 8,000 Crores in 1990-91. In 1990-91, more than 16 per cent of Indian exports were to USSR and about 6 per cent imports came from it. Incidentally, the corresponding trade figures for 2006-07 are 0.7% for exports and 1.3 % for imports. The breakup of the erstwhile Soviet Union coincided with the Indian financial crisis of the early 90s, eventually leading to a collapse of this mechanism with the dissolution of the USSR. Protracted negotiations resulted in a new bilateral trade regime including a debt repayment agreement where both the countries

mutually decided to recalculate the Rouble denominated debt into Indian Rupees. The intergovernmental Letters of Exchange dated January 29, 1993 provide for such recalculation on the basis of the Protocol of November 25, 1978. Simultaneously the Indian Side was granted an interest-free deferment of payments for 45 years covering 37% of its debt, being called the rescheduled portion.[Link]

This debt repayment agreement provided for an annual repayment of about US$ 1 billion equivalent in rupees to Russia over a period of 12 years with smaller amounts thereafter for a further period of 33 years. The rupee debt funds are maintained in a central account with RBI and are to be used by the Russian side for import of goods and trade-related services from India while Russian exports to India are against freely convertible currencies. Approximately two-thirds of Indian exports to Russia are currently routed through the rupee debt funds.

As the official trade between both countries has reduced considerably since 1991, there has been a cumulative shortfall of about US $ 4 billion in the utilisation of the annual debt repayment commitment. The Indian finance ministry’s status report on external debt for August 2007 places the outstanding Rupee debt on the above account from Russia (USSR) at USD 1.949 billion (1.723 billion and 226 million towards defence and civilian components respectively). This unmet outstanding rupee debt prompted the Russian Ambassador at Delhi to earlier suggest that

both sides are considering the possibility of supplementing commodity exports based on Rupee debt repayments with reinvestment of a part of the debt in mutually agreed projects in India and probably in Russia as well, that, we believe, will benefit the economic cooperation between the two countries.[Link]

Russian economic resurgence in recent years has been based on the primacy of its energy trade while the services sector has been the flagship growth sector in the Indian economy. Despite economic policy changes in both countries, the economic relationship between India and Russia is dominated by defence transactions and the military industrial complex still stands at the core of strong Indo-Russian economic linkages. The major purchases from Russia in the recent years include Su-30MK FGR aircrafts, T-72MI and T-90 battle tanks, Ka-31/helix helicopters and variety of other armaments. Major deals worth billions of dollars have been inked or are under serious consideration which includes the aircraft carrier Admiral Gorshkov. The modernisation of this carrier will cost India around $700 million, and the remainder of the billion dollar deal will include MiG-29K fighters and Kamov-31 anti-submarine helicopters. Despite noises to the contrary, military operational logistics imperatives will drive India to continue importing defence equipment and hardware from Russia in the coming years.

Unconfirmed reports have it that the Russians are planning to invest the unexpended portion of the rupee debt repayment back in India with a five year lock in period. This is most likely to include setting up of service centres for defence products already sold to India. More significantly, accumulated rupee debt repayment projects could also be planned as a part of the mandatory DPP-2006 requirement of 30% offset investment in indigenous production for future acquisitions.The readily available capital of debt repayment account will provide the Russians with a distinct advantage over other competitors in the ensuing defence deals. As such, the Russians have a head start over others because of India’s long history of military hardware acquisition from Russia; continuity in operation logistics and generational consistency can only be achieved by adhering to this legacy.

With US $ 40 – 60 billion at stake over the next five years, the lure of the lucre has got the US and the Europeans defence firms already salivating.The latest geo-strategic arm twisting by the Russians is an early indicator of graver things to follow. It will be a test of resolve for the Indians to execute their defence procurement plans amidst all the conflicting pulls and pressures. Recipe for success – a concoction of realpolitik, strategic nous, sang-froid and prospicience. A dash of catholic longanimity while standing up to the bullying tactics of some old friends and many new enemies will do no harm either.

10 Comments »

  1. [...] The immediate answer is that Russia is compelling India to award the US$10 billion tender for the purchase of multi-role fighter aircraft to Russian manufacturers. India’s overall defence technology relationship with Russia is worth a lot more, but this angle cannot be ruled out. But it is unlikely that Russia would have considered issuing such a threat in isolation to the emerging geopolitics in Central Asia. For it would be reckless, even for a hardball player, to issue a threat without insuring against the consequences of it failing to have the desired effect. So what is Russia counting on? Well, China. [...]

    Pingback by The Acorn » Russian armtwisting — September 25, 2007 @ 12:34 pm

  2. Pragmatic, where in heck did you come across this information? It’s been a while since my last visit to IEB and this is something very interesting. For sure this is going to make the defence deals interesting.

    Comment by Nikhil Nayak — October 1, 2007 @ 11:45 pm

  3. Superb summary of the Russian connection and a good analysis of the policy alternatives too I must say! Could we encourage you dwell some more on the alternatives open to us in future as well as the consequences of our choices?

    Comment by little Ram — October 7, 2007 @ 5:06 pm

  4. @Nikhil / Ram,

    Thanks for the encouraging comments. Let’s wait and evaluate the economic costs of our changing geopolitical and strategic relationships. I also lament the lack of any serious discussion on the subject in our media and the blogosphere.

    Comment by Pragmatic — October 11, 2007 @ 9:39 am

  5. [...] The Indian relationship with Russia has a chequered history and the outstanding Rupee debt fund available to the Russians further queers the trade relationship. Time has come to jettison the six-decade old bilateral relationship, more so if does not serve Indian interests in the long run. By opening discussions on extending beyond 2010 their military cooperation pact, India is further tying up its future to a strategic relationship with this aggressive geopolitical player. If India doesn’t assert its independence and non-alignment now, the costs will be too heavy for the Indian establishment to bear in the future. [...]

    Pingback by Pragmatic Euphony » Blog Archive » Russian armtwisting continues — October 19, 2007 @ 1:53 pm

  6. [...] its international stature. During the same time frame as the cryogenic engine fiasco, the “rupee versus ruble” debate flared up in Indo-Russian [...]

    Pingback by Pragmatic Euphony » Blog Archive » Indo-Russian relations Not “Special”… they never were — November 25, 2007 @ 2:48 pm

  7. [...] its international stature. During the same time frame as the cryogenic engine fiasco, the “rupee versus ruble” debate flared up in Indo-Russian [...]

    Pingback by The Indian Economy Blog » Indo-Russian Relations Not “Special”… They Never Were — November 25, 2007 @ 3:20 pm

  8. India should according to its benefit. We should have a good relationship with Russia as it was the only friend who supported all the decades. but the Indian foriegn policy should see beyond Russia for Economic, Military, Industrial growths etc

    Comment by Harry — January 6, 2008 @ 7:05 pm

  9. Benjamin Disraeli once said “we have no permanent friends only permanent interests” every major country but ours understands this.

    Comment by Shantanu Chatterjee — January 7, 2008 @ 5:25 pm

  10. As the economies of the U.S., Europe and Japan all contract, China’s dependence on export manufacturing places it in a position of extreme vulnerability: http://www.globalsecuritieswatch.org/PRC_Sovereign_Risk_Review.pdf

    Comment by Lawrence Summers — August 23, 2008 @ 1:25 am

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