Key Takeaways from this scenario:
1. If the Rupee-Ruble (INR/RUB) mechanism works out, then the market can expect an appreciation in the value of the rupee against the U.S. dollar (USD/INR) in the short to mid-term. It can be expected to be followed by other nations too.
2. The surge of crude oil price is anticipated to continue as a result of cost-push inflation and shortly will be reflected in the retail prices. Although India is buying from Russia in more volume, it still accounts for less than 1% of the total oil volume required. Accumulation of all global events such as Saudi Arabia’s oil site is under attack, the U.S. embargoes the Russian oil, and Europe is considering following the same is expected to increase the burden on other oil-producing countries and accelerate the oil price.
Undoubtedly, oil has always remained an important commodity. Trends in oil demand are highly correlated with economic growth rates, transportation modes and production, and wealth accumulation. In the ongoing conflict between Russia and Ukraine, India faces the dilemma of old strategic alliances or humanities. India chose to follow inflight guidance “secure your safety first, and then assist the other person”. Furthermore, it took the advantage of a Russian offer and decided to buy crude oil at a discovered price along with a low cost of transportation and insurance. According to the article in Financial Times, the discount on the Russian Urals is about USD 25-30 a barrel, while freight rates would add up to USD 3-4 per barrel.
As of 18th March 2022, India imported 360,000 barrels a day. India plans to import 203,000 barrels per day for the rest of the month. On a similar line, Indian Oil (NS:IOC) Corporation bought 3 million barrels of Russian Urals for May delivery from trader Vitol. India requires importing approximately 85% of crude oil while Russia accounts for around 2-4% of the total imports. A Nomura report stated that a discount is anticipated to assist India in the import bills since every 10% hike in crude oil price results in a 0.3% increase in the gap in India’s current account deficit (CAD) and weaken the rupee further. The story gets more interesting when both the countries explore different payment options and decide to evaluate the Rupee-Ruble trade mechanism. This certainly will have an impact on dollar dominance and affect the foreign reserves holding.
The rupee-ruble trade mechanism will enable Indian exporters to be paid INR for their exports to Russia rather than dollars or euros. Under this arrangement, a Russian bank will open an account in an Indian bank and vice versa. Although, the feasibility along with the exchange rates system is under discussion. However, this is not the first attempt by the countries to replace the petrodollar with the domestic currency for trade. This initiative will have a strong impact on foreign reserves. Many countries hold a considerable proportion of the U.S. dollar as a foreign currency asset in the reserves because it is the only currency used for trading crude oil and other petroleum goods, known as the petrodollar.
Table 1: Indian Foreign Exchange Reserves (USD, Million) (Source: RBI) 
The foreign currency assets account for 89 to 93% of the total reserves in India. The oil transaction in the rupee would inversely affect the USD valuation in the market as the demand for dollar funding through FX swaps by Indian oil companies will reduce.
Table 2: Global foreign exchange reserves by currency over time (share in %) (Source: RBI, IMF COFER statistics)
As per the IMF COFER statistics, in March 2021, USD continues to maintain the dominant position in the composition of global foreign exchange reserves with approximately 59.5 percent allocation. USD in the reserves of other countries creates an artificial demand for the currency that increases as nations use more energy. The artificial demand keeps the currency strong in the relation to other currencies, enabling the U.S. to borrow money at lower rates and extending the scope of U.S. financial sanctions. Therefore, the rupee-ruble mechanism can be a breakthrough for the global market as it will decrease the dollar dominancy in the market. Similarly, even Saudi Arabia and China are in discussion to trade oil in Yuan.
Source:
RBI
Financial Times
IMF