Currency futures trading in the domestic market and a foreign exchange derivative instrument traded overseas may be partly responsible for the volatility in the rupee and the currency plumbing new depths over the last few days.
This was suggested by two studies in the Reserve Bank of India’s Annual Report.
Referring to the jump in the value of transactions in exchange-traded currency derivatives from September 2008 to June 2013, an RBI study said that “This period has also shown an increase in volatility in exchange rates.”
According to the study on the ‘Relationship between exchange rate volatility and futures trading’, the value of transactions in exchange-traded currency derivatives in rupee terms, on an average, increased from Rs 260 crore in September 2008 to Rs 23,440 crore in June 2013.
A currency futures contract is a transferable contract to exchange (buy/sell) one currency for another at a future date at a price that is fixed at the time of entering the contract. Currency future contracts allow investors to hedge against foreign exchange risk.
In the spot market, the rupee closed at a life-low of 64.60 and tested an intraday record low of 65.65 per dollar on Thursday due to heavy demand for the greenback from importers and foreign banks.
On MCX-SX, the US Dollar-Indian Rupee currency futures contract maturing on August 28 was last traded at 64.8150 (buy) and 64.8225 (sell) per dollar.
Non-deliverable forwards
The central bank said the rupee value is at times influenced by trading in non-deliverable forwards (NDF) – foreign exchange derivative instruments traded over-the-counter that are based on non-convertible currencies such as the rupee and traded in international financial centres (such as Singapore and Hong Kong).
Importantly, being an offshore market, the NDF market remains outside the regulatory purview of local authorities. Domestic banking entities, foreign banks and corporate entities with an international presence can participate in the NDF market.
NDF does not require physical delivery of currencies at maturity and is typically settled in an international financial centre in foreign currency, usually in dollars. They enable hedging of exchange rate risk, irrespective of any restrictions arising in the country of origin.
Meanwhile, to India’s mitigate external sector vulnerability, the RBI said short-term debt needs to be contained, imports of oil and gold need to be moderated and structural impediments need to be removed in areas such as coal and iron ore.
Improving export competitiveness is crucial to address the issue of the high current account deficit (CAD).