A Reserve Bank of India (RBI) panel on Friday said the country should introduce currency futures to boost the range of financial instruments available for companies and investors to guard against exchange-rate fluctuations, and to open up currency trading to a larger base of investors.
Officials in the finance ministry said this could help policymakers manage the consequences of a sharp, 12.5% appreciation of the rupee against the dollar this year.
The officials, who did not want to be identified, said that the broad aim of introducing currency futures was to allow a large number of small exporters to easily hedge their anticipated earnings and create conditions for more two-way movement of the rupee.
For all of 2007, the rupee has moved in only one direction against the dollar, up.
India’s foreign exchange reserves rose to $270 billion on 9 November. The rupee hit a near-decade high of 39.16 to the dollar last week. It closed trading at 39.33 on Friday.
Robust Rupee (Graphic)
Currency futures are exchange-traded derivatives that allow investors to buy or sell a currency on a future date at a fixed price.
The panel said that RBI, which would be the only agency responsible for regulating the currency futures market, should introduce trading in futures contracts with a unit size of $1,000 and maturity periods of up to 12 months.
It studied the impact of introduction of currency futures in emerging markets where capital control is being practised and came to the conclusion that “currency futures market can and does co-exist with capital controls”.
The panel suggested that trading in currency futures be initially opened only to residents and recommended the creation of a dedicated exchange for such instruments.
Currently, companies and banks in India hedge their foreign exchange positions through forward contracts in an over-the-counter (OTC) market, which is a decentralized market that is not as transparent as an exchange.
Entry barriers in the OTC market in India are high on account of stringent regulations. “The main advantage of currency futures over the closest substitute product, forwards traded over the counter, lie in price transparency, elimination of counter-party credit risk and wider reach,” said the draft report of the panel.
The 98-page report has been put on the website of the central bank.
“The move is one step closer to the final goal of capital account liberalization. In the long-term, futures presents a good deal,” said Samiran Chakraborty, chief economist, ICICI Bank Ltd.
In the near future, a currency futures exchange is unlikely to significantly introduce two-way movement as economic fundamentals do not support it, he added.
“To have a two-way movement, you need a fundamental story,” Chakraborty said.