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India, whilst widely regarded as a rapidly developing region for financial markets, whose economy has improved dramatically over the last ten years, is far less synonymous with the FX business than similarly populous nations in Asia which are the focus of many firms, including China, Malaysia and Indonesia.
Whilst less interest has been displayed in gaining clients from India, it is still a region whose inhabitants are relatively well educated and have a distinct interest in electronic trading. Indeed, the financial landscape in India is most certainly geared up to contend with other Asian nations in terms of structure, and emerging executing venues such as the Dubai Gold and Commodities Exchange (DGCX) have majored on Indian business, with that particular bourse attributing much of its strong performance over the last two years to the burgeoning interest in its Indian Rupee futures contract.
To provide detailed insight into the dynamics of the FX industry in India, and most importantly, into the direction in which it is destined, Harun R Khan, Deputy Governor of the Reserve Bank of India spoke at the 25th Annual Forex Assembly in Gurgaon, India.
The mere fact that this event has a history spanning 25 years demonstrates India’s clear understanding of the FX market and has witnessed the technological developments which have materialized over the last quarter of a century.
Mr. Khan stated that as far as recent developments in the FX market are concerned, measures to stem the sharp and substantial depreciation of the Rupee have been taken whereby policy makers resorted to a mix of policy measures including forex market intervention, monetary tightening through reduction in banks’ access to overnight LAF, increase in MSF rate and increase in daily minimum CRR maintenance requirements and administrative measures, such as, import compression of non-essential items like gold, opening of special dollar swap window for the PSU oil companies, special concessional swap window for attracting FCNR (B) deposits, increase in overseas borrowing limit of banks, bringing of outward FDI flows to the approval route, reduction in Liberalised Remittance Scheme (LRS) entitlement, disallowing banks from carrying proprietary trading in exchange traded derivatives, etc. The Reserve Bank made net sales to the tune of US$ 10.8 billion in the forex market during the period May-August 2013.
Mr. Khan conferred that he considers it to be quite disheartening to see that the trading activity in the option market has declined drastically during the recent period. As per the data reported to the CCIL Trade Repository (TR), the average daily volume in the inter-bank USD/INR option market remained at US$190 million in August 2014, a fall of about 45 per cent from the levels two years back.
The average daily volume in the inter-bank USD/INR options is currently just about 2.6 per cent of that of inter-bank USD/INR forwards. The decline in the inter-bank option trading volume is attributed to fall in the usage of options by the clients as well as fall in the proprietary trading by banks.
India’s Reserve Bank understands that it is a well-recognised fact that the option contracts provide lot of flexibility to the end users for hedging their currency exposures in cost effective ways. The plain vanilla option contracts may be combined in various ways for reducing the cost of hedging. The Indian currency option market needs to be rejuvenated to cater to the needs of various real sector economic agents. As you are aware, the Reserve Bank in its latest Annual Report has announced to expand the option market in the coming years to allow market participants to hedge more easily and cheaply.
Going forward, the Reserve Bank will actively engage with the banks and other stakeholders in bringing out necessary regulatory changes to foster promotion of liquidity in the option market. As an important step in this direction, we would like market bodies like FAI/FEDAI to give us a well- deliberated feedback on the need to allow corporates to write covered options and also take on simple structures like call-spreads with appropriate safeguards.
Foreign Portfolio Investors (FPIs) were allowed to participate in the exchange traded currency derivatives (ETCD) on June 20, 2014 for the purpose of hedging the currency risk arising out of the market value of their exposure to Indian debt and equity securities. The participation of FPIs in the ETCD has, however, remained muted so far with open interest of about US$ 11 million as on September 30, 2014. The participation of FPIs in the OTC currency derivatives also remained quite low. As announced in the Annual Report, the Reserve Bank could consider further measures for extending access to the OTC currency derivatives to the international stakeholders over the medium term.
The Reserve Bank also intervened in the forward market resulting in doubling of net forward liabilities to US$ 9.1 billion as at end-August 2013 from US$ 4.7 billion in July 2013. Apart from monetary and administrative measures, the flow encouraging measures, such as, enhancement of FII investment limit in government debt by US$ 5 billion to US$ 30 billion was undertaken in June 2013.
Mr. Khan has observed that the special forex swap facilities extended by the Reserve Bank at concessional rate for fresh longer term FCNR (B) deposits and banks’ overseas borrowings along with enhancement in their overseas borrowing limits led to forex inflows in excess of US$ 34 billion that aided in restoring stability of the Rupee.
He stated that the Reserve Bank undertook the concessional swap facility as an exceptional measure with the broader public policy objective of bolstering the forex reserves for strengthening Bank’s market intervention capability. Similarly, the swap windows to meet oil demand were conceived as a purely temporary dollar lending arrangement to OMCs. The swap window did attract a fair amount of criticism from the perspective of execution of the second leg but thankfully the Reserve Bank can look back at these temporary arrangements with a sense of satisfaction of restoring confidence and stability in the foreign exchange market and India’s external sector outlook.
As far as alignment and FX related trade with other nations and subsequently the flow of the rupee against other currencies is concerned, the special forex swap facilities extended by the Reserve Bank at concessional rate for fresh longer term FCNR (B) deposits and banks’ overseas borrowings along with enhancement in their overseas borrowing limits led to forex inflows in excess of US$ 34 billion that aided in restoring stability of the Rupee.
The Reserve Bank undertook the concessional swap facility as an exceptional measure with the broader public policy objective of bolstering the forex reserves for strengthening Bank’s market intervention capability. Similarly, the swap windows to meet oil demand were conceived as a purely temporary dollar lending arrangement to OMCs. The swap window did attract a fair amount of criticism from the perspective of execution of the second leg but thankfully the Reserve Bank can look back at these temporary arrangements with a sense of satisfaction of restoring confidence and stability in the foreign exchange market and India’s external sector outlook.
The access to the OTC foreign exchange derivatives has been subject to production of documentary evidence in support of the underlying exposure except for hedging of probable exposures and special dispensations offered to SMEs, individuals and firms. The primary objective of the regulation has been to restrict the use of OTC foreign exchange derivatives by the corporate clients for hedging their exchange rate risks and not for trading in the instruments. Trading in derivatives requires sophisticated risk management skills and BIS central bankers’ speeches financial acumen which are not the natural strengths of corporate entities barring a few large corporates who are into treasury operations as an independent profit centre.
Further, the trading activities of authorised dealer banks are subject to strict governance and regulatory standards which the corporate entities even with sophisticated treasuries are not subjected to.
The Reserve Bank of India is aware of active intra-day/short term trading by some corporate houses in the foreign exchange government securities market. In the past, the Reserve Bank has imposed restrictions on cancellation and rebooking of forward contracts by the corporates so as to curb their speculative trading that accentuates volatility of Rupee. As huge position taking by the corporates has the potential of destabilizing the market, particularly during periods of uncertainty, Reserve Bank would expect adherence to the spirit of its regulations by such non-bank entities.
Additionally, Mr. Khan has confirmed that the Reserve Bank is fully aware of the need to put in place customer-friendly procedures to encourage greater amount of hedging from the end-users. In the past, the bank has taken several measures to simplify the documentation requirements for facilitating easy access to foreign exchange derivatives; recently it has increased the limit of hedging without documentation to US$ 250,000.
For the full report from the Bank for International Settlements, click here.