The Reserve Bank of India (RBI) believes that they will have to build a robust market to provide ample opportunity for all kinds of trades, including the speculative trades.
“When in the underlying cash market, the exchange rate exhibits great deal of volatility, it is natural that there will be a spurt in activities in the derivatives market for different motivations: for hedging actual exposures, for arbitraging and also for speculation. So far we have responded by restricting the freedom of market participants to enter into derivative transactions with a view to curbing speculation and panic-driven trades. Looking ahead, we shall perhaps have to build a robust market which will provide ample opportunity for all kinds of trades, even speculative ones, without upsetting the apple cart,” said G Padmanabhan, executive director at the Authorised Dealers' Conference at Agra on November 30.
Padmanabhan also believes that there is a need to provide adequate instruments suiting every market participant’s hedging strategy.
“Hedging is an agent’s choice, depending on his risk appetite. The market must provide adequate instruments suiting every market participant’s hedging strategy. As of now the instruments available are the linear derivatives and the plain-vanilla options. Hedging is not cost-free.
There is a view that an agent must have the freedom to choose which risk to what extent he should hedge and instruments he uses to hedge. In this context, it is necessary to introduce different styles and structures of options which will enable the market participant to optimise on his hedging strategy.
"For this to happen, it is imperative that the risks and pay-offs of these instruments are properly understood and in this the Authorised Dealers as market makers play a very constructive role,” he said.
RBI agrees that the significance of the Non-Deliverable Forwards (NDF) market is increasing and this market is also becoming responsible for rupee volatility.
“Though we do not have definitive information about the nature or impact of the NDF market, the fact that it has been growing in size is not disputed. In times of exchange rate volatility, the discussion of NDF becomes animated and a large part of the blame for the volatility is laid at its door. Be that as it may, with increasing financial integration with the global economy and ever growing body of investors with an Indian interest, it is no wonder that Rupee should attract global attention. The home country bias for the bond and equity investor is to a large measure due to exchange rate risk; perhaps even the hedging market too has a home country bias. We have to make all efforts to bring that market onshore. But the market that can entice them has to be complete and flexible with less restrictions on entry or exit,” said Padmanabhan.