Hemant Mishra/Mint
Hemant Mishra/Mint

The export of Indian markets is almost going undetected

SGX's attracts large investors compared to Indian markets where the proportion of traders is higher.

IntercontinentalExchange Inc. and CME Group Inc., among the world’s largest futures exchanges, will launch rupee-dollar futures contracts this month. This clearly shows the growing importance of the rupee in the global currency market. A little over two years ago, Bank for International Settlements (BIS) released its triennial central bank survey on foreign exchange and derivatives market activity, which pointed out that about half of the dollar-rupee market was overseas.

Needless to say, large electronic exchanges will do their best to both capture market share and increase the size of the market. And given their advantage over domestic competitors of access to foreign market participants, as well as freedom with product design, the share of offshore trading could continue to rise. But what’s far more worrying is the rapid rise in trading and open interest in the Nifty futures product on Singapore Exchange (SGX). SGX now enjoys a 68% share in the total open interest on Nifty futures contracts.

But first, the reasons for the rise in offshore currency trading. As pointed out in this column earlier, while the central bank has done away with many capital controls, access to the currency market onshore still has some restrictions. This has supported the growth of the opaque offshore non-deliverable forward market. One concern is that intervention by the central bank in the onshore market would get less effective, if the majority of rupee-dollar trading happens overseas.

Having said that, it must also be noted that most emerging market currencies are traded heavily in prominent currency trading centres such as Singapore, Hong Kong, the UK and the US. This is an inherent feature of currency trading. Of course, countries which have capital controls tend to push a larger proportion of trading offshore.

Indian policymakers need to wake up to the changing dynamics of the rupee-dollar market. According to reports, one of the central bank’s deputy governors said last month that foreign investors may be allowed to participate in the currency futures market. This will help the onshore market compete better with the fast growing offshore markets.

While the decline in the share of onshore trading in currency derivatives calls for some policy action, what is far more alarming is the rapid decline in National Stock Exchange’s share in Nifty futures trading. Unlike currency derivatives, equity derivatives contracts by and large have a home bias, and are traded largely onshore. While this has been the case for much of the history of the Nifty futures product (launched in 2000), things changed when Securities and Exchange Board of India banned participatory notes (p-notes) in October 2007. SGX’s share in the total open interest (outstanding positions) in the Nifty futures product rose to around 50% from as low as 6% before the ban. A year later, the market regulator lifted the p-note ban, which led to a fall in SGX’s share to around 25%. But since then, SGX’s share has been rising steadily again. The impact on foreign investors’ sentiment owing to the general anti-avoidance rules (Gaar) resulted in an exodus as well. And while the government has softened its stand on Gaar considerably, foreign investors now seem increasingly concerned about the uncertainties of Indian policymaking.

In addition, they don’t have to worry about securities transaction tax. SGX’s share in the total open interest is now at an all-time high of around 68%, according to data collated by Edelweiss Securities. Its share in turnover is lower at around 30% (based on a 20-day moving average), which again is near an all-time high.

SGX’s high open interest-volumes ratio shows that it is able to attract large investors who are sticky, compared with the Indian markets where the proportion of short-term traders is much higher. If these investors were trading on Indian shores instead, the mix of participants would be much better.

Examples of equity and interest rate derivatives trading shifting by such a large extent offshore locations are few and far between, and it’s time Indian policymakers woke up to this. This column has argued often against the imposition of securities transaction tax. In addition, the finance ministry must also communicate clearly its policies regarding foreign investors. Sadly, there are no signs of even a recognition of the danger of important Indian markets being exported overseas.

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