High net-worth individuals planning to invest in assets abroad may now be able to hedge their currency exposure as well, with Dubai’s futures exchange set to begin trading Indian rupee contracts within two months. Each rupee-dollar contract will represent Rs20 lakh and the prices will be quoted in US cents per Rs100.
The central bank currently allows an individual to invest up to $50,000 (Rs21.5 lakh) overseas every year. “The rules are not very clear whether this $50,000 investment window will include exposure to currency trade, but certainly one can use this exchange for hedging risks even if not punting on the rupee,” said a foreign exchange dealer who did not wish to be quoted.
“As of now, people can trade in other currency contracts such as euro-dollar, dollar-yen contracts, but there were no contracts in the home currency,” said Mohan Natarajan, director, Kotak Commodity Services.
The Dubai Gold and Commodities Exchange launched West Asia’s first currency futures in June 2006.
The rupee on Wednesday closed at Rs42.93 a dollar and has risen more than 3% since the end of December to its highest level in nearly eight years. Analysts said the rupee’s rise, of nearly 10% from a three-year low of Rs47.04 in July, has increased its overvaluation on a trade-weighted basis. “The risk of a correction either via market forces or by central bank intervention has increased,” said Singapore- based Bank of America strategist Han-Sia Yeo, who expects the rupee to weaken to Rs44 by end-June.
The Dubai exchange will be the first offshore market where rupee futures will be traded. A non-deliverable forward (NDF) market already exists and this offers hedging as well as arbitrage opportunities to corporations and banks between the offshore and onshore markets. The NDF market started in the early 1990s when the investors felt the need to hedge their risks in markets that had capital controls such as India.
“Rupee futures are nothing but an exchange-traded version of a forward contract. The Indian unit has been trading offshore for a long time now and the exchange will standardize the trading procedures. For instance, there will be a standard size of contract and maturity period and margin requirement and so on,” said Mumbai-based foreign exchange expert A.V. Rajwade. He sees three types of players to be playing at the exchange—speculators, arbitrageurs and those who cannot access the forwards market in India for regulatory reasons.
NDFs are foreign exchange derivative products traded over the counter and the parties of an NDF contract settle the transaction by making a net payment, the difference between the agreed forward exchange rate and the spot rate of the currency on the maturity date, in a convertible currency, typically the US dollar. Analysts say the Dubai exchange will also follow the same principle as the rupee is not convertible yet. Singapore and Hong Kong have large NDF markets.
Development Credit Bank’s head of treasury operations Harihar Krishnamurthy said the Dubai futures market will have advantages over the NDF market in terms of transparency of price discovery.
According to a Bank of International Settlements survey in 2004, the daily trading volumes in rupee NDF was between $20 million and $100 million a day. The Tarapore Committee on Capital Account Convertibility in 2006 estimated the daily turnover at $100 million. Foreign exchange dealers said the daily turnover of rupee trade in the NDF market could be as much as $500 million. This is, however, small compared with the onshore rupee market in India where daily turnover in the cash dollar market is around $3-4 billion and in the forward market $10 billion. The reason behind the growth in the NDF market is globalization without free capital flows in India. “The exchange will make the local currency virtually convertible as it will give an opportunity to punt on the currency, which is not possible in India where every foreign exchange trade has to be backed by an underlying transaction,” said a banker. He also felt that rupee futures trading would offer a hedging tool to Indian corporations that do not have any hedging tool in the local market except for rupee options.
“This is another sign of the rising interest in the Indian currency for those hedge funds or foreign institutional investors who do not have exposure to the Indian currency market due to stringent local norms,” said Ananda Bhoumick, senior director with Fitch Ratings.