The Reserve Bank of India (RBI) established the Task Force on Offshore Rupee Markets in February 2019. Chaired by Smt. Usha Thorat, former Deputy Governor, RBI, the task force was created to address issues concerning the offshore Rupee markets and to propose suitable policy measures. The ultimate objective was to maintain the external value stability of the Rupee, which included initiatives to encourage non-residents to participate in the onshore foreign exchange market. The report has been recently submitted to the Governor.
Key Recommendations
One of the critical propositions is that Indian banks should not be permitted to interact with the offshore rupee derivative markets, also known as Non-Deliverable Forward (NDF) markets, for the time being. It was noted that the onshore rupee derivatives market is presently deeper and more liquid compared to its offshore counterpart. Therefore, the participation of Indian banks might jeopardize this advantage over time. NDF is a type of foreign exchange derivative contract where two parties agree to exchange cash at a set spot rate on a future date. The contract is settled in a commonly traded currency such as the US dollar.
Improving Access for Overseas Users
The task force recommends extending the onshore market hours to make it more accessible for overseas users. It should also allow Indian banks to offer prices to global clients at all times, either via a domestic sales team or staff based at overseas branches. Another recommendation includes broader access to the forex-retail trading platform for non-residents, which would significantly incentivize them to use the onshore market.
Allowing Rupee Derivatives Trading in International Financial Services Centers (IFSC)
The task force suggested enabling rupee derivatives, settled in foreign currencies, to be traded in the IFSC in India. It further recommends allowing users to engage in forex transactions up to USD 100 million in the over-the-counter (OTC) currency derivative market without needing to establish underlying exposure.
Facilitating Non-Residents to Hedge Forex Exposure Onshore
To facilitate non-residents’ hedging of their foreign exchange exposure onshore, the task force proposes the establishment of a central clearing and settlement mechanism for non-resident transactions in the onshore market. Other suggestions include implementing margin requirements for non-centrally cleared OTC derivatives, allowing Indian banks to post margins abroad, harmonizing the tax treatment of foreign exchange derivatives with major international centers, and centralizing the KYC requirements across financial markets with standard documentation requirements.
Understanding Onshore vs Offshore Currencies & Currency Derivatives
‘Onshore’ refers to buying the currencies within the country, while ‘offshore’ means obtaining the currencies outside the national boundaries. Currency derivatives are exchange-based futures and options contracts that let one hedge against currency movements. In short, a currency future contract can be used to exchange one currency for another at a future date at a price decided on the day of the contract purchase. In India, these derivative contracts can be used to hedge against currencies like Dollar, Euro, U.K. pound, and Yen.
| Currency | Settled In |
|---|---|
| Dollar | Rupee |
| Euro | Rupee |
| U.K. pound | Rupee |
| Yen | Rupee |
Trading in Currency Derivatives
Trading in currency derivatives is facilitated by two national-level stock exchanges, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), which both have currency derivatives segments. Currency derivatives can be traded through brokers.
Over the Counter (OTC) Market
Before the introduction of currency derivatives on exchanges, the Over the Counter (OTC) market was the only place to hedge currency risks where forward contracts were negotiated and entered into. Primarily a closed and opaque market, it was mostly utilized by banks and financial institutions. The exchange-based currency derivatives segment, a regulated and transparent market, can now be used by small businesses and even individuals to hedge their currency risks.
