By Arjavee Indraneesh
With increased transparency in the Indian economy and greater cross border capital flows, non-resident interest in the Rupee has gone up significantly, both for risk management purposes or speculative ends. This is pointing the need for wider participation of rupee forward markets in on-shore markets.
In this context, the Reserve Bank has been guided by the objective of developing a deep and liquid on-shore foreign exchange market that acts as a price setter globally. With regard to non-resident entities having legitimate exposure to the Rupee, the focus of policy efforts has been to align incentives for non-residents to gradually move to the domestic market, with adequate safeguards to ensure the external stability of the value of the Rupee.
The sharp growth in the offshore trading volumes in the Rupee non-deliverable forward (NDF) market in recent years likely even beyond the volumes in the onshore markets have raised concerns around the forces that are determining the value of the rupee and the ability of authorities to ensure currency stability. This necessitated a deeper understanding of the causes underlying the growth in those markets and identification of measures to reverse the trend. The task force was supposed to go into these aspects, along with other relevant details.
A task force appointed by the RBI has submitted its report, which has recommended a number of steps to develop a deep and liquid onshore foreign exchange market that acts as a price setter globally.
The team, headed by former deputy governor Usha Thorat, was mandated to study the factors attributable to the growth of the offshore Rupee market, its effects on the Rupee exchange rate and onshore market liquidity, and formulate measures to redress the concerns. It was also charged to examine the role, if any, that International Financial Services Centres (IFSCs) can play in addressing these concerns. These forward contracts are traded in the OTC market at offshore locations, such as the International Finance Centres (IFCs) in Dubai, Singapore, Hong Kong, London and New York.
The currency markets for rupee, especially for exchange against the USD, are fairly well-developed today. These include spot versus derivatives, over-the-counter (OTC) versus exchange-traded and onshore versus offshore. Further, derivatives can be cash-settled or delivery-based. The most commonly referred benchmark exchange rate of the rupee is from the onshore, spot OTC market. Similarly, the commonly referred forward exchange rate of the rupee is from the onshore forward OTC market. Rupee futures and options are traded in some onshore as well as offshore exchanges.
These forward contracts are traded in the OTC market at offshore locations, such as the International Finance Centres (IFCs) in Dubai, Singapore, Hong Kong, London and New York.
The task force has recommended that the onshore market hours may be suitably extended to match the flexibility provided by the offshore market, thereby incentivizing non-residents to hedge in the onshore market.
It also favours allowing the banks to freely offer prices to non-residents at all times, out of their Indian books, either by a domestic sales team or by using staff located at overseas branches.
The task force has recommended the launch of exchange traded currency derivatives involving Rupee and permitting International Financial Centres and overseas banking units to trade in non-deliverable Rupee derivatives.
The panel endorses principle-based regulatory approach on hedging by non-residents. Also endorsed is back-to-back hedging by non-residents. It has recommended the establishment of a central clearing and settlement mechanism for non-residents’ deals in the onshore market., at the same allowing Indian banks to post margin outside India.
Other recommendations include the introduction of a technology-based solution to centrally aggregate the investments of non-residents and derivative contracts entered into by them in the onshore market, examining the issue of taxation in respect of foreign exchange derivative contracts with the objective of overcoming gaps between tax regime in India and other major international financial centres to the extent possible and centralised KYC registration across the financial market with uniform documentation requirement.
if India opts for full rupee convertibility, which means removing all restrictions on current and capital account transactions, along with removal of all restrictions on currency derivatives, then offshore markets would no longer be a relevant concept. But the issue has not moved beyond the debating table, which implies that offshore markets are here to stay for the long haul. (IPA Service)