Home / Opinion / Is RBI’s intervention in currency futures markets unfair?

The Securities and Exchange Board of India (Sebi) said last Friday that some banks authorised by the central bank will be permitted higher position limits in the dollar-rupee futures market. This will usher in an arbitrary and non-transparent process into the otherwise largely transparent exchange-traded markets, and hence reflects poorly on both regulators. Without doubt, banks that aren’t given such an authorisation will cry foul.

But there is a larger issue at stake, we are told. Some proponents of free markets claim that the newly created special status will be reserved for state-owned banks that trade on behalf of the central bank. One of them, a senior executive at a private bank who wants to remain anonymous, says that the Reserve Bank of India (RBI) can potentially corner 50% of the total market-wide open interest using this new provision, and hence manipulate the exchange rate.

Sure, although the last time we checked, India has a managed float exchange rate system, or, as some call it, a dirty float. In other words, the exchange rate market has been a manipulated or managed market for years now. As one academician says, traders in India’s currency markets surely know that they may well be trading against the sovereign.

The only thing that has changed in recent months is that RBI has become increasingly interested in intervening through the exchange-traded market as well, apart from the over-the-counter market.

What about the argument that the exchange-traded market is expected to be a transparent platform for price discovery, and that the central bank should keep its hands away from it? But how can this be expected? The currency futures market can’t exist in a silo. Outstanding contracts in the futures market are settled using spot prices—yes, a reference price that’s based on a poll, but it isn’t far removed from the spot price.

Note that this isn’t a discussion of whether it is appropriate for a central bank to include exchange rate management as part of its mandate. Instead, since that is a given, it’s difficult to argue that RBI should stay away from certain markets for its intervention activities.

In fact, in its defence of the franc till early this year, the Swiss National Bank straddled various markets across geographies. Using this approach, RBI may well be justified in trading in the non-deliverable forwards markets in London or other popular financial centres. It may not yet have the wherewithal to effectively intervene in these markets, but just having a trading presence can provide useful insights.

Be that as it may, it does look unfair to allow larger position limits to only a few privileged banks. These few banks, it can be argued, may well use the larger position limits to take higher positions on their own proprietary account. The regulators could have instead asked exchanges to relax position limit requirements for all banks—and if that isn’t an option, a relaxation could have been made only for trades that are flagged as trades by the central bank. The current circular gives an impression that the regulators are being both arbitrary and discriminatory, which should have been avoided.

The central bank’s increasing presence in the currency futures has led to an increase in open interest on exchanges in recent months. But on the flip side, participation by end-users has declined. Policy makers should be acutely aware of the needs of this segment of the market as well; else the purpose of the creation of exchange-traded markets will be lost.

The open interest itself looks impressive. On the National Stock Exchange (NSE), it currently stands at $6.6 billion for dollar-rupee contracts. In fact, any bank can take positions worth around $1 billion at present on the NSE, since position limits for banks are set at 15% of total open interest or $100 million, whichever is higher. The authorised or privileged banks will be able to take position limits of $1 billion or 15% of total open interest, whichever is higher. Prima facie, they seem to have no advantage.

But these limits, for some strange logic, are per exchange limits. BSE has a total open interest of only $1.7 billion, and the privileged banks will have a far higher limit compared to other banks in this market. Even on the NSE, at expiry, when positions are squared off or closed, open interest drops, and in such times, the authorised banks will be able to take larger positions vis-à-vis other banks. With RBI effectively asking for larger limits, overall open interest in these markets should increase.

But for market quality to increase, participation by Indian companies must grow. The central bank should lift the restrictions it put in few years ago, and also follow through on proposals such as allowing more trading hours for exchanges. It should also lift the bizarre rule on per exchange limits, which forces companies to trade on multiple platforms.

We welcome your comments at inthemoney@livemint.com

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