Business Standard

Rising speculativ­e bets drive RBI crackdown on currency derivative­s


Excessive speculativ­e bets in the domestic currency derivative­s market is perceived as the primary catalyst behind the Reserve Bank of India’s (RBI’S) decision to clamp down on those engaging without any underlying exposure.

According to sources familiar with recent central bank norms on exchangetr­aded currency derivative­s (ETCDS), the Foreign Exchange Management Act (Fema), 1999, prohibits speculatio­n against the Indian currency.

“Will the Government of India permit speculatio­n against the rupee? Is India prepared to endorse policy-driven speculatio­n surroundin­g the rupee?” asked a source elucidatin­g the central bank’s stance.

Last week, the RBI deferred the implementa­tion of norms on ETCDS linked to the Indian rupee until May 3, citing investor concerns that the move could drain liquidity.

The norms were initially slated to take effect on April 1.

Rupee-denominate­d currency derivative­s contracts are actively traded on the National Stock Exchange (NSE), the BSE, and partially on the Metropolit­an Stock Exchange of India.

In principle, all trades necessitat­e an underlying exposure. However, traders are not mandated to furnish evidence of underlying exposure for positions up to $100 million; they must confirm the existence of such exposure.

Following the press conference after last week’s monetary policy, the RBI censured investors for “misusing” the guidelines.

Data highlights a sharp rise in the average daily trading volume (ADTV) in the ETCD segment during the postpandem­ic era. The ADTV in 2021–22 surged to ~1.41 trillion, up from ~70,470 crore in the preceding year, according to combined data from the NSE and BSE. The majority of the volumes stemmed from NSE trades.

However, ADTV came off the cliff in

April amid uncertaint­ies over open positions lacking underlying exposure. ETCDS have won investor favour in recent years, whereas products like credit default swaps and interest rate futures have yet to gain traction.

Data from the Securities and Exchange Board of India revealed that proprietar­y trades accounted for twothirds of the turnover in 2022-23 on the NSE, with foreign portfolio investor shares comprising roughly 9.5 per cent.

Market observers note that a major portion of options interest stems from intraday traders, indicating speculativ­e activity in the ETCD market. This, they argue, complicate­s rupee management for the RBI.

“Lately, concerns have arisen regarding the escalating use of algorithmi­c trades in the ETCD market. Foreign trading firms operating from tax-friendly jurisdicti­ons have become increasing­ly active. These participan­ts add little value to the ecosystem and exert pressure on the rupee,” commented an official from a brokerage.

The RBI said that the regulatory framework for participat­ion in ETCDS involving the rupee is governed by the provisions of Fema. Regulation­s mandate that currency derivative contracts involving the rupee — both over-the-counter and exchange-traded — are permitted solely to hedge exposure to foreign exchange (forex) rate risks. Sources indicated that whenever the Indian currency faces pressure, it is primarily from the ETCD and non-deliverabl­e forwards markets. Historical­ly, the central bank has intervened in the spot, forwards, and currency futures markets to alleviate volatility.

The RBI has been proactive in managing the exchange rate, contributi­ng to the rupee’s status as the most stable emerging market currency in 2023–23. The central bank, which has allowed the currency to depreciate gradually, has also succeeded in amassing forex reserves, now at a record high of $645.5 billion.


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