The Task Force on Offshore Rupee Markets, set up by the Reserve Bank of India, has proposed that Indian banks should not be permitted to deal in the offshore rupee derivative market — or non-deliverable forward (NDF) markets — for the present as the downside of permitting them to deal in the offshore rupee market outweighs the advantages.
However, the panel has recommended extension of onshore market hours to improve access of overseas users and permit Indian banks to freely offer prices to global clients around the clock.
“The onshore rupee derivatives market is currently more deep and liquid as compared to the offshore rupee market and participation of the Indian banks in the offshore market might, over time, take away this advantage,” the panel headed by former RBI Deputy Governor Usha Thorat said. NDFs are foreign exchange derivative instruments on non-convertible or restricted currencies traded over the counter (OTC) mainly at offshore centres outside the direct jurisdiction of the respective national authorities.0
The task force recommends that banks should be allowed to freely offer prices to non-residents at all times, out of their Indian books, either by a domestic sales team or by using staff located at overseas branches. “Also, wide access to the forex-retail trading platform to non-residents would be a major incentive to use the onshore market,” it said.
The sharp growth in the offshore trading volumes in the rupee NDF market in recent years — even beyond the volumes in onshore markets — has raised concerns around the forces that are determining the value of the rupee and the ability of authorities to ensure currency stability.
The panel, which submitted its report on July 30 to the RBI, examined the causes of the underlying the growth in the overseas NDF markets and identification of measures to reverse the trend.
The task force has proposed rupee derivatives (settled in foreign currency) to be traded in the International Financial Services Centers (IFSC) in India, to begin with on exchanges in the IFSC. It proposed allowing users to undertake forex transactions up to $100 million in OTC currency derivative market without the need to establish underlying exposure.
It has also mooted facility for non-residents to hedge their foreign exchange exposure onshore by establishing a central clearing and settlement mechanism for non-resident transactions in the onshore market and implementing margin requirement for non-centrally cleared OTC derivatives and allowing Indian banks to post margins abroad. Other proposals include aligning the tax treatment of foreign exchange derivatives with that in major international centres and centralising the KYC requirements across financial markets with uniform documentation requirement.
NDF markets enable trading of the non-convertible currency outside the influence of the domestic authorities. These contracts are settled in a convertible currency, usually US dollars, as the non-convertible currency cannot be delivered offshore. Historically, NDF markets evolved for currencies with foreign exchange convertibility restrictions and controlled access for nonresidents, beginning with countries in South America like Mexico and Brazil and thereafter moving on to emerging Asian economies like Taiwan, South Korea, Indonesia, India, China and Philippines. Apart from enabling trading in non-convertible currencies, NDF markets have also gained in prominence because to onshore regulatory controls and their ease of access.
While there are concerns around impact on the onshore market due to trading in rupee derivatives in the IFSC, there are potential benefits in terms of IFSC’s ability to offer complete bouquet of financial services and availability of market information to all stakeholders. Moreover, given India’s economic growth, it may be appropriate to prepare for greater financial integration with the rest of the world.
Sequencing and timing of measures relating to currency markets is a critical component of such integration, the panel said.