The market for non-deliverable forwards (NDFs) in London on the dollar-rupee pair has grown by leaps and bounds in the past two years, far outpacing other currency pairs. (Sarvesh Kumar Sharma/Mint)
The market for non-deliverable forwards (NDFs) in London on the dollar-rupee pair has grown by leaps and bounds in the past two years, far outpacing other currency pairs. (Sarvesh Kumar Sharma/Mint)

Dollar-rupee trading in London trebles, raising policy concerns

  • If external value of rupee is largely being determined overseas, then RBI’s ability to manage the currency can be challenging
  • RBI recently proposed setting up a task force on offshore rupee markets, well over two years after BIS’s troubling report

How large is the market for dollar-rupee trading in overseas centres such as Singapore and London? Every three years, the Bank for International Settlements (BIS) releases results of its survey on foreign exchange and derivatives market activity. The last one, in 2016, showed that trading on the dollar-rupee pair in Singapore and London was about as much as the size of the onshore market, which was worrying enough.

But if recent data published by the Bank of England (BoE) is any indication, the share of the onshore piece has shrunk considerably in the past two years. A survey by the London Foreign Exchange Joint Standing Committee, chaired by BoE and consisting largely of market participants, shows that the average daily turnover in dollar-rupee non-deliverable forwards (NDFs) soared to $23 billion in October 2018, up from $7.9 billion in the October 2016 survey.

The 2.9 times rise in the dollar-rupee NDF market in London was the fastest among currency pairs for which data was made available by BoE, with the rise in turnover for the dollar-yuan pair being the second fastest at 2.46 times.

While central banks at all major financial centres publish data from similar surveys, such granular data on the NDF market is available only for London and New York. In the latter, the dollar-rupee market grew 1.57 times in size to $4.5 billion daily in October last year. Even if turnover in other large centres such as Singapore ($16 billion daily in the 2016 BIS survey) remained flat, that would mean considerable erosion in the share of the onshore market.

Needless to say, this has obvious policy implications. If the external value of the rupee is largely being determined in overseas markets, then the Reserve Bank of India’s (RBI’s) ability to manage the currency can be challenging. The central bank has, thus far, dismissed this notion, suggesting that price discovery happens onshore and that overseas centres only follow suit.

It’s only recently that RBI has begun acknowledging the growth of the offshore market as a problem. In February, it proposed setting up a task force on offshore rupee markets, well over two years after BIS’s troubling results came out. “The task force will examine issues relating to the offshore rupee markets in depth and recommend appropriate policy measures that also factor in the requirement of ensuring the stability of the external value of the Rupee," said its statement.

BIS data has been called to question in the past, with one rumour doing the rounds that a bank reported the rupee value of trades instead of dollar value, and messed up calculations. A market participant, who did not want to be named, says that the BoE survey may not face such criticisms, as market participants will be more careful while reporting to the home regulator. Still, many are likely to baulk at the $23 billion-a-day figure, suspecting there may be errors of double counting and the like. Even so, considering that the same methodology has been used for the past two years, the 2.9 times rise in turnover is also a worrying sign. For some background on NDFs and data from an earlier BIS survey, click here.

If NDF markets have gained such scale, it will be highly attractive for Indian companies as well to look to these markets for the hedging needs of their overseas arms. Indeed, some experts suspect that could be a factor driving up volumes in centres such as London.

The Indian government’s answer has been to develop an international financial services centre at GIFT City in Gujarat, to try and bring back liquidity from offshore centres. From the central bank’s perspective, of course, G City is another offshore centre, which seems to be the reason it hasn’t yet approved the dollar-rupee contract.

In any case, the real answer to the problem involves making the main onshore market more accessible and attractive. While RBI has taken some measures such as allowing centralized treasuries of multinational companies to access the markets, the task force needs to delve deeper and find solutions.

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