FEMA trouble
- The Reserve Bank of India's (RBI) recent policy reiteration regarding participation criteria for exchange traded currency futures and options contracts has disrupted the functioning of this segment, leading to a significant decline in daily turnover and outstanding contracts.
New Currency Trading Rules Shake Up the Market
- Trading Slumps: Since the RBI's new rules came into effect, daily trading of currency futures and options has plunged dramatically on the NSE.
- This has caused both domestic brokers and foreign investors to scramble to close out their existing positions.
- Liquidity Dries Up: The new rules, which limit who can trade currency derivatives, are keeping a big chunk of usual participants out.
- This includes professional traders and foreign investors, who used to make up over two-thirds of the market activity.
- This lack of participation is threatening the overall smoothness (liquidity) of the market, which could lead to wild swings in the rupee's value and make it harder for businesses to protect themselves from currency fluctuations.
- Volatility Spillovers: Foreign investors who can no longer trade on Indian exchanges might move their business overseas, to markets like the rupee NDF market.
- This shift could cause more volatility in the rupee's exchange rate, impacting everyone involved.
- Background and Concerns: Up until now, currency derivatives on exchanges have been a popular tool, especially for smaller businesses and individuals, to manage their risk from currency fluctuations.
- These exchange-traded options allowed for smaller transactions compared to traditional methods.
- The market has seen significant growth in recent years.
- The Balancing Act: The RBI's new policy aims to crack down on speculative trading and ensure that currency derivatives are only used for legitimate hedging purposes, as allowed by existing regulations.
Way Forward
- Finding a solution might involve working together - the RBI and the government could potentially remove foreign currency derivatives from a particular set of regulations to address concerns about speculation, while still allowing legitimate hedging activities to flourish.