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Opinion | Home appeal

By granting market participants greater flexibility to trade onshore, RBI could attract larger volumes of trading and thus address the problem of an overseas impact

A panel set up by the Reserve Bank of India (RBI) to examine the rising influence of offshore rupee trading on the domestic currency market has made several recommendations for the latter. It has asked for longer trading hours, allowing derivative transactions—usually aimed at hedging risk—up to a limit even without any underlying exposure, and letting banks freely make price citations to global clients round the clock. The trading of rupee forwards in offshore markets—such as Singapore, London and New York—has grown vastly in recent years because of the ease it offers overseas participants in hedging their currency exposure risk without having to register with Indian authorities. Since Indian rules don’t permit the rupee to be delivered overseas, these transactions do not involve an actual exchange of the currency. Settlement takes place by paying the difference in the exchange rate over the period of the forward contract in dollars. This is why such trades are called Non-Deliverable Forward contracts, or NDFs.

The problem is that offshore trading of rupee forwards has grown so rapidly that it is now exerting an unduly large influence over local—or onshore—currency markets. This can be particularly harmful in times of a global crisis, when it can cause excessive volatility and threaten economic stability. During the 2013 rupee crash, for instance, offshore rupee trading contributed significantly to the currency’s record fall. The volatility caused by fleet-footed foreign investors and speculators in these markets had a damaging effect on its value back home, leaving very little that RBI could initially do to stem the slide.

By granting market participants greater flexibility to trade onshore, RBI could attract larger volumes of trading and thus address the problem of an overseas impact. It would also deepen the domestic currency market. The result, hopefully, should be a better managed exchange rate—and in turn financial stability—plus greater regulatory control, which would make it easier to implement RBI’s monetary policy.

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