The rupee’s value,determined offshore by a market that never sleeps

The Indian rupee is not convertible and neither is the Chinese yuan. The rupee trades in India from 9 to 5. But it has found a 24-hour market outside.

Round the clock

The non-deliverable forward (NDF) market operates before the sun rises in India,from Singapore,and long after the sun sets at Mumbai,from Dubai. Since it operates for longer hours and,more important,does not have to run the cost of paying securities transaction tax,it is more efficient than the onshore market. Contracts are settled in cash and payments made only in US dollars. But the commodity traded in is the Indian rupee,bought and sold at a rate based on the difference between the spot rate in India and the NDF rate. In a way,the expansion of this market is in sync with the increase in the size of export-import trade of a country.

So anybody with a sizeable exposure to foreign exchange risks taps this market to hedge his or her position. It is hardly surprising that this market dwarfs the onshore market in terms of size. While the combined daily volumes of the MCX and NSE market is about $8 billion,Singapore itself is bigger.

Every weekday morning,as dealers reach their desks at the Bandra Kurla Complex or the cubbyholes in Delhi’s Kuchha Mahajani,they look at their handhelds for the NDF rates. Banks Indian and foreign trade on the NDF market and are aware how the rupee could swing the next morning.

Hands tied

The Reserve Bank of India too knows about it but can do nothing. The offshore market is legal and outside its ken. So the course for the day is set even before the first trade rings out,as it was on Monday morning when the rupee opened at 60.95. The rest of the day at Mint Street was spent firefighting.

Is the RBI missing a trick here? Its influence on the currency in the offshore market is limited. Within the country its ability to push in foreign exchange in large tranches is limited; a Bank of America Merrill Lynch report says only about $5-10 billion now. This means that the heft of the central bank as the big guy in the currencies market will not be much.

The RBI has a reserve of $ 280 billion,the People’s Bank of China of over $ 3.31 trillion. Indranil Sengupta,India Economist at Merrill Lynch says there is no doubt the RBI needs to build up its reserves.

Sell and defend

On Monday,Reuters reported that RBI likely sold dollars via state-run banks in the afternoon to prevent the rupee from slipping below the 61-per-dollar mark. “The central bank likely sold dollars starting at around 60.92 levels. Not too sure about the quantum,but in this market you hardly need a large quantum,” a senior dealer with a private bank said,suggesting volumes were thin.

But it helped. The rupee strengthened closing at 60.61,still well below its previous close of 60.2250/2350. But when the rupee tanks again,the RBI will have some money less to defend the currency,and dealers in foreign exchange markets know that.

Way ahead

In the absence of a fat wallet,the RBI could favour quantitative restrictions. For instance,the government has mandated that banks can only speculate in the forex market to the extent they are fully funded by underlying assets of their clients. This has cut down on speculation but also thinned out volumes in the market. Manpreet Kaur,senior research analyst at India Forex Advisors,said the low volume meant any forex trades on Monday moved the exchange rate of the rupee disproportionately.

Many are hoping for some intervention from the finance ministry,though government officials say such intervention would have only a limited impact.

“Market participants are anticipating some reforms from the government which may provide a ray of hope for the dwindling currency that may help in bringing foreign capital inflows back on track. Government is also contemplating providing a special window for oil companies to buy dollars. These reforms might work in tandem to stem the precipitous slide in the rupee and bring about some stability to the currency,” said Sugandha Sachdeva,assistant vice-president and in-charge of metals,energy & currency research at Religare Securities Limited.

A possible way out is for the RBI to go back to the Resurgent India Bond and the India Millennium Deposit. This will send market participants the message that it will intervene even though there would be a risk of importing inflation.

But with the rupee dropping into uncharted territory,some more unconventional measures would be welcome. For instance,can the RBI or an Indian public sector bank be designated to invest in the NDF markets abroad? It would of course d