RBI Alters India’s FX Derivatives Market
On April 5, the Reserve Bank of India (RBI) implemented new regulations shaking up the Foreign Exchange Derivatives market in India. These regulations mandate underlying foreign-exchange exposure for currency derivatives trading on stock exchanges, significantly impacting retail traders and speculators who form a considerable portion of the market participants.
Brokerage firms have promptly notified their clients to close their FX derivatives positions before a specified deadline. This move is poised to displace many active participants, potentially leading to a drastic reduction in trading volumes, which had previously reached $5 billion per day.
The RBI’s actions align with its broader foreign exchange management strategy, particularly in anticipation of the country’s bond markets being included in global indexes in June. By curbing fluctuations in the rupee, which has shown remarkably low volatility compared to other emerging market currencies, the RBI aims to stabilize the financial landscape.
The regulation’s requirement for actual foreign-exchange exposure effectively excludes individual traders and speculators, who contribute significantly to the trading volume. There are concerns that up to 70% of the market’s volume could vanish, with half of it comprising arbitragers.
The recent reaffirmation of the circular issued by the RBI caught several market participants off guard. The clarification, issued after an email to the Commodity Participants Association of India, emphasizes that entering contracts without actual exposure violates foreign exchange regulations.
According to HDFC Securities Ltd. currency strategist Mr. Dilip Parmar, the impact of the new regulations will become evident in the following month, with the underlying requirement likely eliminating volume in currency derivatives trading.
The regulatory changes will permit users to liquidate existing currency positions from April 4 but prohibit them from entering new positions without submitting a declaration form. These changes come amid significant foreign investment inflows into the nation’s bond markets since JPMorgan Chase & Co.’s announcement in September.
Overall, it is anticipated that the new regulations will mitigate currency volatility, with the RBI bolstering its foreign exchange reserves to a record $643 billion as a precautionary measure against external disruptions.
