Good news on currency futures

Good news on currency futures

It is good to see that action has picked up in India’s young currency futures market. Despite many premature reports that said this market is struggling, both trading volumes and open interest have shot up in the one month since the first currency futures contracts were traded at the National Stock Exchange, or NSE, helped no doubt by the recent bouts of currency volatility. The competing Bombay Stock Exchange, or BSE, too, has got into the game this week.

There is little doubt that exchange-traded currency futures are still dwarfed by the far larger over-the-counter (OTC) interbank market in India. But the gap between the two markets is likely to be narrowed in the years ahead, for two reasons. One, more participants will be ready to buy and sell exchange-traded currency futures once those markets become deeper and more liquid. Two, the current global financial crisis has its roots in the proliferation of OTC derivatives that were traded under the regulatory radar. It is likely that regulators will be more enthusiastic about exchange-traded derivatives in the future.

We continue to be agnostic between the two. But we would welcome further growth in buying and selling of currency futures on exchanges such as NSE and BSE. It will be a long journey, since the OTC markets will be more liquid than the new currency futures markets for perhaps many more years. As Indian Institute of Management, Ahmedabad professor Jayant Varma has written in his blog: “New markets get their initial momentum from new entrants and not from switchers from old markets. This group of new entrants who value the liquidity of the old market less than the other characteristics that the new market offers start trading and gradually build up liquidity in the new market to the point where it can start attracting switchers."

What lies ahead? First, the current restrictive regulations on currency futures should be gradually eased to bring in more players. Second, the early success of currency futures should encourage regulators to move fast and bring in interest rate futures as well.

Both Indian companies and investors need to protect themselves against gyrations in exchange rates and interest rates.

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