MUMBAI - The Indian central bank has told banks that deal with the United Arab Emirates (UAE) to settle at least a part of their trade payments directly using the rupee and dirham, according to five banking sources.

The Reserve Bank of India (RBI) hasn't given banks a specific target but has asked them to report the extent of such payments to it on a regular basis, the sources said.

The sources declined to be identified as they are not authorised to speak to the media.

The advice goes beyond a 2023 nudge to banks to facilitate such payments after Prime Minister Narendra Modi's visit to the UAE.

An email sent to the RBI seeking comment was not answered.

The move is part of India’s attempt to increase trade settlement in the rupee and reduce reliance on the dollar, an ambition that has evaded most nations. Approximately half of world trade is denominated in dollars, according to the Bank of International Settlements.

In addition to pushing for rupee-dirham settlements, the Indian central bank has renewed discussions to set a mechanism to expand local currency trade with Russia, Reuters reported earlier.

Reuters also reported last year that Indian refiners have begun paying for most of their Russian oil purchased via Dubai-based traders in dirhams instead of dollars.

To encourage the development of a rupee-dirham market, the RBI has said banks should first seek "a matching flow" in dirham from another bank when payments are to be made to UAE, said one of the sources.

Operationally, this would mean that banks would seek a rate for the dirham-rupee pair from another bank, while avoiding going to the market to first convert rupees to dollars and then dollars to dirhams.

The UAE is India's third largest trading partner with annual trade of about $83 billion in the 2023-24 financial year ending March, according to government data. The trade includes over $17 billion in oil and related imports by India.

India had a merchandise trade deficit of $12.4 billion with the UAE in 2023-24. Settling trade in local currencies would help reduce dollar outflows on account of the trade deficit.

The RBI has not instructed banks to shift all dirham payments to this channel but instead is taking steps to encourage the development of an rupee-dirham market, a second source directly familiar with the matter said.

Following the central bank's communication, banks would "perhaps be more inclined to seek a matching (dirham) flow" instead of directly converting the dirham to dollars, which is currently the dominant practice, the second source said.

While banks and clients appear open to adopting the mechanism, the process in a "nascent stage," a third source, also a senior banker, said.

(Reporting by Nimesh Vora and Jaspreet Kalra; Editing by Raju Gopalakrishnan)