Currency Futures Exchange in India- A Step Towards Fuller Currency Convertibility

Indian Rupee ( INR) is partially convertible i.e., while India allows rupee convertibility in current account transactions for travel abroad or education purposes, overseas investments or acquisition of assets, classified as capital account transactions, need central bank approval.The introduction of currency futures is probably the first of the last set of steps towards in the country’s tryst with capital account convertibility.

We have 3 types of markets viz., Spot Market, Forwards Market and NDF market. 

1) Spot Market-  The Price in this market is controlled by RBI. This is called the Reference Rate and is influenced by the RBI indirectly when it buys or sells foreign exchange in the market.

2)Forward Market ( On Shore)- This is an Over - The -Counter market which is accessible only to the domestic players- Hedgers -Importers, Exporters to hedge their foreign currency Risk or Pure Speculators or even Arbitrageurs.

 

Now that we have a Currency Futures Exchange ( NSE , BSE, MCX) in place, we can have

•Efficient price discovery

•Better counterparty credit risk management,

•Wider participation,

•Trading of standardized product,

•Reduced transaction costs, etc.

3) Non-Deliverable Forwards ( Offshore )- India has an NDF market as Rupee has foreign exchange convertibility restrictions. NDF is an unofficial , unregulated market in Dubai, Singapore and London. With controls imposed by local financial regulators and consequently the non-existence of a natural forward market for non-domestic players, private companies and investors investing in these economies can hedge their exposure with NDF's. NDFs are traded generally in offshore centres Without Delivery of the Underlying Currency. The difference between the NDF rate and the prevailing spot market rate( RBI Reference Rate) is settled on the settlement date in a Convertible Currency,ie., the USD. The other currency ,ie., the INR, an emerging market currency with capital controls, is Non-Deliverable.

Monetary management

Now, let us assume the rupee is appreciating at a rapid rate. From a spot rate of Rs 43.5, the futures indicate a rate of Rs 41.5. Assume that Rs 41.5 is not acceptable for the RBI and it goes in for buying up dollars, thus increasing money supply.

This process will be accelerated when the rupee keeps on appreciating and the RBI may perforce be compelled to follow a tight monetary policy as the market will always have the futures rate in its periscope. Therefore, monetary management will become that much tighter.

A final thought on this market is whether or not the RBI could be a player in the market. The RBI is the holder of the reserves for the country and, hence, owns the largest quantity of foreign exchange.