India has increasingly become an open economy and external trade currently accounts for 40 percent of GDP, which is more than that of other large supposedly open economies like China (37 percent) and US (27 percent). Further, acceleration in economic growth offered promising investment opportunities to foreign investors contributing to surge in capital flows. In this context, the Reserve Bank of India (RBI) has treaded carefully along the path of opening up the Indian economy in tandem with growing external linkages through trade and financial channels. This involved a gradual liberalisation of capital flows, increasing FII limits in a calibrated manner, simplifying operational procedures with respect to hedging and implementing measures to deepen and widen forex market in India.
Over last three decades, Indian foreign exchange market has made long strides in terms of turnover, types of instruments and participation base. Average daily forex turnover has increased from approximately $27 billion in 2005-06 to $58 billion currently. Today, we have considerably liquid market as evident in rising forex market turnover and compressing bid ask spreads. There is well functioning over the counter (OTC) as well as exchange-traded market providing diversified range of products for hedging currency risks. As an alternative to traditional forwards market, introduction of derivatives products has helped in minimising cost of hedging and improving transparency.
However, despite this, India’s unhedged exposures stand quite high with various studies and estimates suggesting that approximately two-thirds of total gross forex exposures are unhedged. According to Bureau of Indian Standards (BIS), while the rupee share in OTC foreign exchange turnover has gone up from 0.2 percent to 1.1 percent in April-2016 survey, it is still low compared to other smaller emerging market economies like Mexico (1.9 percent) and Turkey (1.4 percent).
At Edelweiss, we have identified key areas of concerns and needs of market participants by way of conducting a survey across 400 corporate houses.
Key findings from survey:
- 69 percent of corporates surveyed want the trading hours in forex market to be extended beyond the existing time of 9-5 hours Extension of trading hours to cover US, Japan and other major economies will help to manage forex risk /hedge efficiently.
- 73 percent participants believe there is lack of transparency in forex margins charged by banks which could be a reason why 78 percent wish to have currency delivery mechanism on exchanges. Transparency in forex rates, spreads and margins continue to remain a key issue for small and medium enterprise clients. Gross settlement of contracts on exchange can resolve this issue.
- 85 percent want contracts on EURUSD / USDJPY / GBPUSD be allowed on exchanges.
- 86 percent of corporate surveyed want option contracts to be introduced for Euro, Pound and Yen. Availability of options contracts will help to reduce hedging cost and provide alternate methods of hedging.
- 68 percent feel that the existing cap of $15 million per exchange should be increased. Higher position limits without underlying to help corporate hedge contingent exposures and also reduce paper work.
While many steps have been introduced to encourage hedging, Indian corporate and RBI policymakers keep encouraging Indian corporate houses to hedge their forex exposure, and significantly large un-hedged exposures reflect the need to do more. Further, penetration of hedging and other forex products and overall development of forex markets, hinge critically on addressing the needs of end users - our survey has tried to identify lacunae at a micro level.
Extending timings, introducing options in other major currencies, providing currency delivery mechanism and enhancing limits on exchanges are some of the key demands prevailing in the market currently. Addressing these demands will go a long way in improving hedging amongst Indian corporates, which is crucial to reduce risk and consequently improve stability of the financial system.
Sajal Gupta, Head – Forex and Rates, Edelweiss Securities