The government is considering introducing trading in rupee futures contracts on stock exchanges, a move that will bring the country a step closer to full convertibility of the rupee on the capital account of balance of payments.
Accordingly, the finance ministry will be asking the Reserve Bank of India (RBI) to explore the possibility of putting this in place at the earliest.
Futures contracts are a commitment between two parties to effect transactions at a preset price and date.
The move is expected to usher in unprecedented transparency and liquidity in the country’s foreign currency market.
At present, Indian corporates and banks hedge their foreign exchange positions through forward contracts in an over-the-counter (OTC) market, which are decentralized markets, unlike stock exchanges where all orders are matched electronically and in a transparent manner.
The finance ministry has decided to revisit the idea after the Dubai Gold & Commodities Exchange (DGCX) last week announced it would list rupee futures contracts in June, the first time a rupee futures contract will be traded on an exchange.
Allowing similar trades on an Indian stock exchange requires just an executive notification and no legislative changes, said a senior official of the finance ministry, who did not want to be named.
Indian stock exchanges can offer futures contracts, which can be settled at the time of expiry in rupees, the official added. Unlike DGCX’s rupee futures contracts, which are to be settled in US dollars.
The finance ministry wanted to make a broad policy announcement on the introduction of rupee futures contracts in stock exchanges during the course of the finance minister’s budget speech in 2006, said the official. The announcement did not take place as RBI felt the market was not yet ready to trade in rupee futures.
The DGCX move is a sign that RBI needs to loosen controls as forces beyond its control would begin to influence India, said Jamal Mecklai, CEO of Mecklai Financial, a forex advisory.
“You cannot control markets when they start doing things outside what you are permitting,” he said. “It (DGCX’s move) is a loud sign that you need to accelerate your deregulation several notches; if you don’t, you will not only lose business to other centers but, far more important, you will have bouts of unmanageable volatility in your domestic market which will make it progressively more difficult for Indian companies to manage risk.”
There has been a historical precedent where external developments have prompted the government to fast-track its policy. In 1995, the National Stock Exchange (NSE) asked the capital market regulator, Sebi, for permission to start trading in stock index futures. Permission did not come through quickly and on 24 May 2000, Singapore’s SIMEX chose the Nifty, the exchange’s benchmark index of 50 stocks, for derivatives trading on an Indian index. Sebi then allowed NSE and the Bombay Stock Exchange to trade in index futures the next day.
Offshore markets in rupee derivatives exist in Hong Kong and Singapore in the form of non-deliverable forwards (NDF), where the two entities settle for the price difference at the end of contract rather than deliver the underlying security. Contract value on NDF impacts the forward markets in foreign currency in India.
Some observers say currency futures call for a more nuanced approach. “Currency futures is not as simple as it sounds. I don’t think anybody’s going to rush in. Once we enter, there’s no going back,” said Saumitra Chaudhuri, economic adviser at Icra and a member of the Prime Minister’s Economic Advisory Council.
Permitting currency futures would loosen restrictions on capital account convertibility, a factor that concerns Chaudhuri, in terms of the speed with which RBI would act on the finance ministry proposal.
Interestingly, an RBI-appointed committee charged with drawing a road map on capital account convertibility had recommended last year that India allow currency futures.
The finance head of a state-owned oil company, among the largest users of foreign currency hedging mechanisms in India, said the company would keep all options open, following DGCX’s announcement.
At the same time, he maintained that his company was in no hurry to test the new option, since the forward market, where corporates are allowed to offset their legitimate forex exposures, do an adequate job.
The global currency futures market, though small when compared to a currency forward markets, is still very significant.
Despite forward markets accounting for the maximum trade volumes, some studies show that 85% of price discovery in forex markets are on account of futures markets, said the recent report of the high powered expert committee which looked at ways to transform Mumbai into an international financial centre.