The Bank for International Settlements (BIS) has released further details of its triennial central bank survey on foreign exchange and derivatives market activity. Based on the preliminary results it had released in September this year, it had seemed that about half of the dollar-rupee market was overseas.
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The detailed break-up of trading in the dollar-rupee pair now released by BIS confirms this. Average daily turnover in the dollar-rupee pair stood at $42.7 billion in April this year, and only 50% of this took place onshore. The rest was largely split between Singapore (16%), the UK (12%), Hong Kong (11%) and the US (9%). The above data includes spot transactions, outright forwards, foreign exchange swaps, currency swaps, options and other products. This has surprised practitioners and academicians alike. Most experts assumed that the overseas market, or the non-deliverable forward (NDF) market, was much smaller compared with the onshore market. Besides, the assumption was that most of the NDF activity happened in Singapore. The BIS data, however, reveals that there are four large NDF markets for the dollar-rupee pair.
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While there is a general sense of surprise and disbelief, the fact that the data source is BIS is leading to some scrutiny. As one Singapore-based banker put it to his Indian counterpart when presented with the data, “There’s no way the NDF market is that big. But then, we need to make sure it isn’t, so that we don’t lose out on the opportunity.”
The response isn’t surprising considering that NDF markets are opaque and data on them is difficult to come by. In fact, this is for the first time that BIS’ triennial survey includes data on the dollar-rupee pair. According to Prof. J.R. Varma, who has been tracking this data, wrote in his blog: “One of the reasons most people underestimated the size of this market is that they were looking only at Singapore, while the market is spread across several locations.”
The relatively large size of the NDF market points to the increasing globalization of emerging markets, especially in the past five years or so. NDF markets are primarily used by those who don’t have unrestricted access to the onshore market, despite having an underlying exposure to the rupee. Besides, speculative positions can’t be taken in the onshore market and NDF markets offer a convenient alternative, especially since there is an increasing international interest in the currency.
A paper by Guonan Ma, Corrinne Ho and Robert N. McCauley of BIS titled The markets for non-deliverable forwards in Asian currencies explains how these markets are birthed. “Before January 2001, deliverable Indonesian rupiah forwards were actively traded offshore, mostly in Singapore, and non-residents enjoyed easy access to rupiah funding. To reduce speculative pressure on the rupiah, rupiah loans and transfers by banks to non-residents and related derivative transactions were prohibited or restricted by Bank Indonesia in January 2001. This effectively limited the offshore deliverability of the rupiah and dried up trading in offshore deliverable rupiah forwards. To meet the offshore hedging or speculative demand, an offshore market in rupiah NDFs gradually developed over the following months.”
While the Reserve Bank of India (RBI) has removed various capital controls, access to the onshore market still has some restrictions. This has supported the growth of the NDF market. But with the offshore markets having grown to such a large size, one policy implication is that intervention by the central bank in the onshore market would get less effective. As one expert puts it, “The central bank’s influence on the dollar-rupee rate would decrease.”
To tackle the growth of the NDF market, the Tarapore committee on fuller capital account convertibility had recommended in mid-2006 that restrictions on foreign institutional investors should be reduced and they should be allowed to cancel and re-book forward contracts and other derivatives contracts booked to hedge rupee exposures. RBI did allow some relaxation in this regard in early 2007, but there continue to be restrictions. Assuming the NDF market is indeed as large as what the BIS data claims, these are some policy issues that need to be revisited.
But more importantly, the data points to increasing globalization of the Indian currency, with large markets for it available across the globe in different time zones. There need to be policy responses to even take advantage of this development.
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