Monetary policy review: RBI allows rupee derivatives trade in IFSCs

According to BIS, NDFs in six currencies account for two-thirds of the trade in the NDF globally

The Reserve Bank of India (RBI) on Friday allowed banks to freely offer foreign exchange prices to non-resident Indians at all times, and said trading on rupee derivatives will be allowed and settled in foreign currencies in International Financial Services Centres (IFSCs). 

The Gujarat International Finance Tec-City (GIFT) is one such IFSC planned for India. These were two major recommendations by the Usha Thorat committee on offshore rupee markets, which was aimed at bringing the offshore markets to India. 

The other recommendations are getting examined by the RBI, the policy statement said.  

The issue here is that the non-deliverable forwards (NDF) markets have garnered volumes much above the domestic market. However, the RBI has no control over the offshore markets. 

According to Bank of International Settlements (BIS), NDFs in six currencies — Korean Won, Indian Rupee, Chinese Renminbi, Brazilian Real, Taiwanese Dollar and Russian Ruble - account for two-thirds of the trade in the NDF globally. The total daily average volume in NDF markets was about $200 billion as per a BIS survey, where the share of India was about 18.22 per cent. 

In 2016 itself, offshore trades in Indian rupee were “more or less equal to deliverable onshore forwards,” the BIS data had found. The 2019 data is yet to be available. A 2018 Bank of England survey reported $23 billion in offshore rupee trades, while RBI sources estimate deliverable daily onshore forwards at $21 billion, which shows that offshore rupee derivatives markets are now deeper than the onshore market. 

Even as the IFSC is located in India, for all practical purposes, it is an offshore market such as those in Singapore, Hong Kong, London, Dubai and New York. But bringing volume to Indian shores would mean better information dissemination. In the offshore NDF market, no physical delivery of rupee takes place, but its volume far outstrips those in the domestic interbank market. 

“The sharp growth in the offshore trading volumes in the rupee 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,” the task force report had said in August. 

The RBI said directions for implementing the two recommendations of the Usha Thorat committee will be issued in consultation with the central government and other regulators.

The Thorat committee had recommended free quoting of prices because foreign portfolio investors (FPIs) as well as global corporates were unable to access multiple competitive quotes in the onshore market, and effectively, they were limited to using the prices of their custodian banks. This is also because the custodian banks were responsible for tracking of outstanding hedges vis-à-vis portfolio size. 

This “friction” issue can be addressed by shifting the monitoring to a centralised agency which can use a technology solution to track exposures as well as outstanding hedges. 

“One way of making onshore prices more widely accessible to non-residents is to allow Indian banks to freely offer prices as liquidity providers to non-resident customers at any time, whether or not the domestic market is open. They can extend to non-resident corporates the same choices that domestic corporates have in choosing among various market makers,” the committee had recommended. 

The other recommendation, to bring the offshore market onshore, was driven more by the quest to get information, even as the regulations remain off limit for these markets. 

“While there are concerns around impact on the onshore market due to trading in Rupee derivatives in the IFSC, there are potential benefits in terms of IFSC's ability to offer complete bouquet of financial services and availability of market information to all stakeholders,” the task force had noted. 

“… a thriving Rupee market in the IFSC may provide a system which can be leveraged towards this end, in the way and manner deemed fit in future. IFSC being outside the capital controls provides an opportunity to policymakers to test new regimes and products in an environment whose repercussions may not significantly impact the stability or efficiency of the onshore system,” the Thorat committee had noted.