The rupee strengthened sharply on Tuesday after the Reserve Bank of India (RBI) imposed restrictions on the ability of banks to take positions in the exchange-traded futures and options markets, a move which, along with steps by the capital market regulator, was aimed at putting the lid on speculation and halting the slide in the currency.
In a late Monday evening notification, RBI said banks “should not carry out any proprietary trading in the currency futures/exchange-traded currency options markets”. Any such trades could only be on the behalf of clients.
The Securities and Exchange Board of India (Sebi) followed this up on Tuesday by raising margin requirements (or the money to be provided upfront on trades) and curtailing open positions (which limits the extent of trading) on currency derivatives starting 11 July.
The early impact on the rupee was substantial—it opened considerably stronger at 59.70 a dollar, after having slid all the way to yet another record intra-day low of 61.21 a dollar on Monday. That had prompted RBI to sell dollars heavily in the market, dealers said, boosting the currency to a 60.61 close.
The rupee was however unable to maintain its buoyancy on Tuesday, slipping and closing at 60.14 a dollar. According to currency dealers, this level was achieved after the central bank sold dollars at the 60.20 a dollar level.
Following RBI’s measures late on Monday, one-month rupee forwards strengthened sharply to 60.68 a dollar from 61.15 levels on Monday. In opening trade, offshore contracts had risen 1.6% to 60.31 per dollar, the most since 28 June, according to Bloomberg. The Dollar index, which measures the US currency’s strength against major currencies, rose to a three-year high of 84.753 at midday in New York.
At close, the rupee was the second highest gainer in the region, having risen 0.78%.
The moves by RBI and Sebi are aimed at ending speculation in the domestic markets, analysts said.
Banks, the biggest investors in foreign exchange markets, act as market makers. In their absence, trading volume will likely crash, said treasurers of banks.
Other speculators too will likely get out of the market as RBI is keeping a keen eye on the derivative segment, said treasurers. The central bank has access to disaggregated data, which allows it to pin down any rogue, speculative positions. Dealers said the message has gone out to speculators that RBI is resolved to shore up the rupee and this should serve to keep them out for some time.
Data at the end of the day showed that open interest in currency options and futures had nosedived. Open interest had already slumped on 27 June when the central bank banned foreign institutional investors (FIIs) from trading independently in currency futures and options.
Any such trade could only be undertaken after the consent of clients, RBI told FIIs.
The number of open positions in options and futures dipped to 21,41,763 and 20,93,888, respectively, on Tuesday from 26,95,487 and 25,70,318 on Monday, National Stock Exchange data showed. On 26 June, the day when the rupee crossed 60 to the dollar, the open positions in options and contracts were 50,94,629 and 34,96,994, respectively. RBI banned speculation by FIIs the next day, and called up bank treasurers informally, asking them to cut speculative positions, bringing the open position to 18,66,256 and 25,20,420 in options and futures.
“Banks do manipulate the market. There is no doubt about it,” said Pramit Brahmbhatt, chief executive at Alpari Financial Services (India), the domestic arm of the world’s largest currency trading platform provider for retail investors.
Analysts explained how this happened. Even as RBI has significantly curtailed the ability of banks to speculate in the currency market by limiting open positions, they were allowed to carry out proprietary trading, which they clubbed with their clients’ hedging requirements.
According to analysts, banks used to enter the market on behalf of clients and, based on their trading calls, hold an intra-day position on their own books. If favourable, banks used to extend this for the day, keeping their positions open. RBI’s latest guidelines and Sebi’s exhortation that the margin requirement on the domestic dollar-rupee forward trade has to be 100% of the traded amount, should end this practice.
One casualty of this move will be dealing desks and advisories that used to informally advise banks on such trades and sometimes trade on behalf of banks. These entities, which used to take positions on behalf of banks for as little as two minutes, will now have to be wound down.
“Volumes in pound sterling is so low that a trade of 2,000 lots, or just £2 million, would have moved the value by 5 paise. All you need is just 3% of the volume to have a 3 paise movement,” explained Brahmbhatt. Banks, with their deep pockets, were capable of causing such movement.
The price will be paid on another front as banks were also the market makers in derivative trades. With liquidity getting hampered and banks not able to give two-way quotes effectively, the market will suffer.
That encouraged the view that the restriction may be temporary.
“It is a temporary phase, I am sure, unless RBI wants to kill the market altogether, which I doubt,” said the head of treasury at a private bank, who did not want to be named.
Even though liquidity will be hampered in the short term, this however should not be a cause for concern, said Ananth Narayan G., head of global markets (South Asia) at Standard Chartered Bank. “It will impact liquidity and transaction cost will go up, but the market is deep enough that genuine hedging requirement for corporates won’t be impacted,” he said.
“This step has to be accompanied by other steps to control current account deficit to have a positive impact on exchange rates in the long run,” he said. India’s current account deficit shot up to a record 6.7% of gross domestic product in the third quarter, but improved to 3.6% in the fourth quarter.
To further curb currency volatility, RBI also ordered state-owned oil companies to purchase their dollar requirement from a single public sector bank, PTI reported.
RBI issued orders to Indian Oil Corp. Ltd (IOC), Hindustan Petroleum Corp. Ltd (HPCL), Bharat Petroleum Corp. Ltd (BPCL) and Mangalore Refinery and Petrochemicals Ltd (MRPL) to stop seeking quotes from several banks for the $8-8.5 billion (Rs.48,000-51,000 crore) they need monthly, regarded as one of the reasons for the currency weakening.
IOC, the nation’s largest refiner, will buy its monthly requirement of $3.8-4 billion from its official banker State Bank of India. Similarly, BPCL, HPCL and MRPL will buy their dollar requirement from a single bank, the PTI story said.
According to currency dealers, rising oil prices will have a significant impact on the exchange rate. This follows some signs of economic revival globally.
After dipping in April, oil prices have started inching up in July. Brent crude is now trading at about $107.38 a barrel, up from $100 on 21 June.