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Taming the offshore rupee market

The alternative venues for foreign exchange trading that once lurked in the shadows are now beginning to take centre-stage and policymakers are now beginning to realise that this threat needs to be urgently tackled. Offshore trading in few currencies has burgeoned to such an extent that it is higher than the onshore trading volume.

In a bid to contain the damage done by the offshore market for rupee, the RBI recently made two policy changes based on the recommendations of a task force headed by Usha Thorat. One, it has now allowed domestic banks to freely share foreign exchange rates with non-residents and, two, trading in rupee derivatives has now been allowed on International Financial Services Centres.

It is, however, doubtful if the RBI’s measures will have any immediate impact. The crux of the problem is that central banks cannot restrain offshore trading in their currencies, unlike stocks and bonds issued by domestic entities. As the chief of an offshore currency exchange explained, the central banks have control only on the currency. But since currencies are traded in pairs, for instance dollar-rupee, euro-rupee, yen-rupee, etc., these trades are beyond regulatory purview if conducted on foreign soil.

That said, the central bank can make rupee trading volumes migrate to onshore markets by improving the trading conditions onshore and increasing the acceptability of the rupee in global markets.

The offshore market

The report of the task force explains the growth, issues and solutions for these offshore markets for currencies in a comprehensive manner, which can act as guideposts for future policy actions. The growth in offshore trading in rupee was prompted by a variety of reasons, including restrictions in participation of non-residents in domestic markets, non-convertibility in the capital account, limited time of operations of domestic exchanges and a booming underlying economy.

As the number of foreign investors in the economy grew, their need to hedge their exposure has led to growth in these offshore centres, given the issues in the domestic markets. Growing speculative interest in the rupee, due to the fast-paced growth of the economy, is another reason behind the thriving trading in rupee overseas.

The NDF market for the rupee is located in IFSCs such as Singapore, Hong Kong, London, Dubai and New York. According to the numbers disseminated by the Bank of International Settlement and London FEC, the daily average rupee trades in the offshore NDF market in 2013 was $17.2 billion, while turnover of rupee forwards in the domestic market was only $3.2 billion.

While trading in the domestic forwards market grew to $21.4 billion by October 2018, trading in the NDF market too moved higher to $23 billion. In other words, trading in rupee forwards is higher in offshore markets compared to the domestic market. The rupee currently is the most traded currency in the NDF market after Korean Won.

The exchange traded currency derivatives (ETCD) market for the rupee is in comparison much smaller, about 10-15 per cent of the forwards market. But the onshore market for rupee ETCD also accounts for only around 50 per cent of the total volume. Around 50 per cent of the total rupee ETCD volumes are traded on offshore exchanges in Dubai, Singapore and Chicago.

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