There has been an uncharacteristically muted response by international investors to the Reserve Bank of India’s move three months back to allow foreign portfolio investors (FPIs) to hedge onshore currency risks arising out of their exposure to the Indian debt and equity markets.
FPIs were allowed by the RBI, in June this year, to access the currency futures or exchange traded currency options market to hedge onshore currency risks in India, a move that was touted as a significant initiative in attracting dollar inflows into the country.
With open interest of only about $11 million till September 30, 2014, the RBI is now likely to supplement the move by “further measures” for extending FPI access to the OTC (over-the-counter) currency derivatives over the medium term.
According to RBI data, the participation of FPIs in the exchange traded currency derivatives (ETCD) has, since the step was announced on June 20, remained muted, with open interest of about $11 million till the end of last month. Participation of FPIs in the OTC currency derivatives also has remained quite low.
FPIs include foreign institutional investors and qualified foreign investors. Currency futures and exchange traded currency options are together known as exchange traded currency derivatives.
In the coming months, the RBI is expected to calibrate a further opening up of the FPI investment limits in G-secs (government securities), with the overall objective of prudential management of the capital account in general and mitigating the impact of speculative carry forward trade in particular, according to officials in the central bank.
During recent months, the central bank had said that it had noted trends of volatile FII flows in the short-term debt market that were impacting the foreign exchange markets, forcing the RBI to restrict FPI investments to only dated government securities having residual maturity of three years or above. The overall G-sec investment limit, however, remained unchanged at $30 billion.
The RBI’s policy objective in opening up investment limits in G-secs was two-fold — containing the interest rate and exchange rate volatility and developing the debt market by attracting long-term stable investment flows through endowment funds, pension funds, and sovereign wealth funds.
In the meantime, the central bank has been smoothening the process and procedure relating to investments by international players, including direct participation in trading, introduction of a ‘T+2’ settlement and the possible introduction of international settlement linked to domestic trading system.
A currency future is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. Exchange traded currency option is a standardised product that gives the buyer the right but not the obligation to buy or sell the underlying (currency exposure) at a specified date and at a stated price.