The Hindu Business Line : Policy on speculation: To be or not to be

The RBI permits cross-currency trading which could cause forex losses; but has clamped down on MIFOR swaps which are purely rupee derivatives though priced using USD interest rates.

THE Reserve Bank of India (RBI) has given a quite burial to MIFOR swaps.

The structure of the MIFOR swap was unique: one leg consisted of the US dollar-fixed swap rate plus a fixed premium representing potential USD/INR appreciation over the life of the swap. The floating leg was 6-month LIBOR and the 6-month forward premium on USD/INR. The latter two would be reset every six months. Though the swap contained USD interest benchmarks, it was devoid of currency risk because the fixed and floating payments would be in INR.

This is what probably attracted the ire of the RBI. Keen though it is to promote the use of derivatives in the domestic market, the central bank must have felt MIFOR swaps meant overstepping bounds, for it enabled Indian (corporate) entities to bet on US interest rates.

Some fundamental issues are involved here. There has been considerable financial liberalisation in the last decade — the rupee is on a (managed) float, bank deposit and lending rates have been deregulated, Government too borrows at market rates for risk-free paper through RBI auctions and foreign portfolio investments can come in with few restrictions.

Beyond these is the critical question of whether speculation (in the sense of banks, corporates and individuals taking outright positions based on their market views) should be allowed. It is here that confusion seems to reign.

For, there are quite a few things on which the RBI should make up its mind. While speculation is accepted as part and parcel of stock markets and is freely allowed, forex, bond and derivative markets pose different problems. The RBI is clearly (rightly) against unbridled speculation in dollar-rupee. So is the case with gilts where short-selling (i.e., selling without ownership) is forbidden. But this is diluted because both banks and corporates can assume pay fixed positions in interest rate swaps, which is the same thing as short-selling.

Basically, the point is whether trading (speculative) positions are going to be allowed and if so, in which segments of the market. The RBI permits cross-currency (i.e., dollar/yen, euro/dollar, etc) trading, which could cause forex losses (and thereby drain reserves), but has clamped down on MIFOR swaps, which are purely rupee derivatives (so no potential forex impact, though priced using USD interest rates). This is tantamount to allowing speculation in the most volatile of markets — global currencies — and curbing it in the more placid interest rate markets.

Clarity on and segregation of the implications of allowing speculation in the domestic market in rupee financial products vis-à-vis those designated in foreign currencies are essential to evolve a consistent policy framework in these matters. The baby should not be thrown out with the bathwater as, for example, has happened after MIFOR has been discarded, leaving the market bereft of instruments to hedge long-term USD/INR risk.

More Stories on : Forex | Financial Scan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page