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The Reserve Bank of India (RBI), concerned about the fastest growth in currency derivatives trading in a little over three years, is asking foreign funds to prove they were not speculating on the rupee.
Futures and options trading involving the currency rose 47 per cent to a daily average of Rs 38,770 crore ($6.4 billion) in June on the National Stock Exchange of India, the biggest jump since January 2010. Exchange rate volatility jumped the most in almost two years during the last quarter as the rupee slid 8.6 per cent, Asia's worst performance. The spot rate plunged to an unprecedented 61.21 a dollar on Monday.
RBI on June 26 asked foreign funds for proof individual accounts were seeking to limit currency risk on securities by using derivatives. The central bank has also enquired about foreign lenders' open positions involving the rupee. Global investors can only use rupee futures and options to protect their holdings of Indian shares and debt.
"There is increased participation from speculators as currency markets are very volatile," Supreeth S M, CEO, Quant First Asset Advisors India Ltd, Bangalore, which manages about $100 million in options, said in a July 3 telephone interview.
"Companies having external debt payments and those hedging are actively accessing the market." RBI spokeswoman Alpana Killawala did not immediately respond to an e-mail sent outside of business hours.
Downward spiral
While the central bank has no direct oversight of exchange trading, it is concerned the speculative nature of the contracts will lead to a downward spiral in the spot exchange rate, according to J Moses Harding, who has resigned as executive vice-president at IndusInd Bank here.
The surge in transactions in exchange-traded currency derivatives is partly due to the central bank's curbs on trading in forwards and over-the-counter futures, which are under its purview, according to Kanji Pitamber & Co.
RBI said in May 2012 futures and options positions on exchanges can't be netted or offset by those in the OTC market, following measures in December 2011 that banned rebooking of cancelled forward contracts. Forwards are agreements to buy or sell assets at a set price and date.
Lowering the limit on net open positions "cuts market liquidity and makes the rupee more volatile," Unnati Parekh, head of currency derivatives at Kanji Pitamber, a 78-year-old brokerage, said in a July 2 interview in Mumbai. "By reducing liquidity in the market you can control, you are just encouraging movement into the non-deliverable forwards market."
NDF transactions
Non-deliverable forwards (NDFs), settled in dollars, evolved for currencies such as the rupee and yuan, which aren't fully convertible. Spot transactions involving the rupee equalled $30 billion in 2010, while NDF volumes were more than $40 billion, according to a December report from the London School of Economics & Political Science, citing a 2010 survey by the Bank for International Settlements.
Investors with foreign offices can buy dollars in the onshore derivatives market and sell these in the NDF market to benefit from the difference in prices, Naveen Raghuvanshi, a trader at Development Credit Bank Ltd in Mumbai, said in a July 3 telephone interview.
The one-month futures contract on the NSE here closed at 59.85 a dollar on June 26, while a similar maturity NDF was at 61.06, data compiled by Bloomberg show. The spread between the futures and NDF contracts widened to a five-year high of 121 pips that day before collapsing to 13 on June 27, a day after the RBI's latest directive. A pip is the smallest unit of a currency's price, which in US dollar terms equals one-hundredth of a cent.
Derivatives usage
Few Indian companies use currency derivatives and the boards of a "very large number" prohibit using them for hedging, according to a July 3 report by KPMG.
In a KPMG survey of treasurers and chief financial officers across 100 Indian companies, 79 per cent said they used forward contracts for hedging. Twenty-one per cent covered at the spot rate, 45 per cent favoured plain vanilla options and while three per cent used exotic options, according to the report. Last month's surge in derivatives trading outstripped equity contracts, which rose two per cent. The value of commodity derivatives deals fell 14 per cent in the two weeks through June 15 from the previous period, latest data from the Forward Markets Commission show.
The surge in currency derivatives trading reflects the rupee's relatively large swings, Chetan Jain, an analyst at Anand Rathi Financial Services Ltd in Mumbai, wrote in a July 3 e-mail. Arbitragers also have more scope to "optimise returns," he said.
One-month implied volatility in the rupee, a gauge of expected moves in the exchange rate used to price options, rose 452 basis points last quarter, the most since September 2011.
Parekh from Kanji Pitamber said, "The latest RBI notification looks to cut speculation and allow only actual hedging."
He added, "So, we have to see how this will play out on the futures and options volumes."
