Foreign Currency

RBI rule ambiguity wrecks FX derivatives boom, exposes regulatory gaps in India

India’s once-thriving FX derivatives market, a playground for speculative bets on the rupee, now faces a regulatory reckoning. The central bank’s crackdown, demanding underlying exposure for all trades, has sent shock waves through the market. This disconnect between the regulator’s intent and market understanding exposed potential gaps in India’s regulatory framework, raising concerns for investors and jeopardizing the country’s image as a stable investment destination, according to a report by Reuters.

“There seems to be a disconnect between the regulator’s intent and market perception,” said Smrithi Nair, a legal advisor. “This confusion creates a negative image for India as an investment jurisdiction.”

For years, the market thrived on bets on the rupee’s movement, even without traders holding underlying assets. A rule allowing transactions up to $100 million without proof of exposure was interpreted by many as a green light for speculation, the report added.

This all came crashing down in late March when the Reserve Bank of India (RBI) reaffirmed a long-standing rule: rupee derivatives can only be used for hedging actual foreign currency exposure from April 5. This move effectively pushed out a large portion of the market–speculators who formed the bulk of trading volume.

The RBI claimed its rules have always mandated underlying exposure for derivative trades. Deputy Governor Michael Patra accused some participants of “misusing” the system, the Reuters report noted.

Traders, however, argue they understood the $100 million threshold as an exemption for exposure proof. This ambiguity persisted even after a January circular from the RBI reminding exchanges of the underlying exposure requirement, as per the Reuters report.

The RBI has delayed implementation until May, but maintains its stance. Analysts believe the move aims to curb currency volatility, a metric India excels at managing, with its substantial forex reserves.

“This is surprising for a large economy with strong reserves and low currency volatility,” said Ashish Barua, a former banker and now a derivatives trader. Barua was forced to exit his positions at a loss and plans to shift focus to other markets.

The unintended consequence of this crackdown could be a market with fewer participants, potentially harming genuine hedgers who rely on a healthy ecosystem for efficient risk management. “All types of participants are crucial for a market’s health,” said Narinder Wadhwa, a market expert. “Speculators add liquidity and create a better environment for hedgers,” he was as quoted as saying  by Reuters.

(With Inputs from Reuters)

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Published: 12 Apr 2024, 09:18 AM IST

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