An increasing number of bankers and traders in major financial centres such as Singapore and London are inking deals in derivative contracts on the rupee, even while existing rules laid down by India’s apex bank, the Reserve Bank of India (RBI), severely limit such transactions within the country.
The frequency of such deals, usually made over the telephone, has increased even as the rupee rides on the back of India’s growing economic power and takes toddler steps towards becoming an international currency.
People who trade in this market estimate the value of such transactions to be $1-1.5 billion (Rs3,970-5,955 crore) a day.
“It is a very good leading indicator of global thinking on the rupee,” said Jamal Mecklai, CEO of Mecklai Financial, a Mumbai-based forex advisory firm.
There is more than national pride involved in the phenomenon of the rupee becoming an international currency. It indicates that the currency has become mature and interesting enough from the investment point of view, resulting in more traders taking positions on it.
In April, the Dubai Gold and Commodities Exchange announced it would allow trading in rupee-dollar futures contracts starting June.
The announcement encouraged the Indian government to start thinking in terms of alllowing such contracts here. A discussion paper to this effect has been circulated by RBI and the government hopes to allow trading in currency futures before April.
Indian laws limit the quantum of over the counter hedges that can be sold to companies seeking to protect their earnings against any unexpected volatility in the exchange rate. The new proposal seeks to allow trading of such hedges on exchanges in a transparent manner.
Futures contracts are a commitment between two parties at an exchange to effect transactions at a preset price and date.
The rigid rules have already encouraged people looking for trading or hedging opportunities to trade in non-deliverable forward (NDF) markets in the rupee in Singapore, Hong Kong and London.
NDFs are forwards contracts where investors make a call on the future exchange value of the rupee against the dollar.
They are generally settled in dollars and traded over the phone.
Exporters or other companies with a dollar exposure use NDF trades as hedges.
“The demand for NDFs arises principally out of regulatory and liquidity issues of the underlying currencies,” said an RBI report on forex markets.
Analysts say the growing market for NDFs is a manifestation of a larger trend of the internationalization of the rupee as the Indian economy continues to expand by over 9% a year.
The country’s gross domestic product (GDP) is at present estimated at a little over $1 trillion and its economy is considered the third largest in terms of purchasing power parity, which accounts for the exchange rate differential between countries.
Trades in NDFs started 10-12 years ago. Until five or six years ago, the value of trades was around $50 million a week, according to Mecklai.
This has increased to between $500 million and $1.5 billion a day, he said. Much of this has to do with the growth of the Indian economy.
In a recent article in The Wall Street Journal (it has an exclusive content partnership in India with Mint), economist Ajay Shah wrote that while the country’s GDP grew from $240 billion in 1992 to $1 trillion in May, gross capital flows into the country rose from $97 billion to $1 trillion in the same period.
India, evidently, is where some foreign capital wants to be.
Still, the growth in international interest in the rupee has outstripped the pace at which regulatory barriers to trade in forex derivatives within India have been removed.
Policymakers are not able to quite comprehend the interest in the rupee for a variety of reasons, said a senior finance ministry official, who did not want to be identified.
A consequence is that financial intermediaries in India are losing out on potential fee income as restrictions have led to the markets moving to centres such as Singapore and London.
“When Indian financial regulation obstructs derivatives, offshore production of these products helps end-users to obtain these services and thus undertake better risk management of their securities portfolios. This helps the sophistication and growth of the Indian economy,” said the report of a committee headed by Percy Mistry.
The Mistry committee had looked at ways to transform Mumbai into an international financial centre.
This is the first in a two-part series on the internationalization of the rupee. The second and concluding part will run on Wednesday.