‘Hedging forex exposure on exchanges cheaper’

With the rupee turning volatile since last year, hedging foreign exchange exposure has become an imperative for all foreign exchange earners and spenders. Pramit Brahmbhatt, CEO, Veracity Group, explains why small importers and exporters should consider exchange-traded currency futures for their hedging needs. Excerpts:

How does the cost of hedging compare between the inter-bank market and the currency futures market?

On spread basis, the exchange is 8 to 10 times cheaper than banks. The spread in banks is 3 to 4 paise, whereas in the exchange, it is just a quarter paisa.

There is greater transparency in the exchange. You have the terminal and you can see the rates yourself. But while dealing with banks, you have to go by what the bank quotes. If you are a small exporter or importer, the banks might quote higher rates.

How about brokerage and other costs? What is the hedging cost in currency futures and in the inter-bank markets?

Broking firms charge a brokerage of ₹1,000 for ₹1 crore. The exchange cost is around ₹300-400. So the total cost will be around ₹1,300-1,400.

In case of a bank, if a bank takes a spread of four paise for a $2-lakh transaction, it means it will charge you ₹8,000 for the transaction.

So, from ₹1,300 to ₹8,000, the cost of transaction is almost six times higher with banks.

But isn’t the mark-to-market system in exchanges a problem for small traders?

The final impact is the same whether you pay mark-to-market on a daily basis, or you pay the bank at the end of three months. Also, in the exchange, 8 per cent is the margin requirement for the dollar, and for non-dollar, it is 3-4 per cent margin. But with the banks, the margin for non-dollar currencies is almost double — 8-10 per cent.

With the exchange, if you have stocks or any fixed deposit, you can use that instead of paying the physical margin. You earn interest on your fixed deposit and also use that as a guarantee.

However, futures is still in a developmental stage.

But they have increased the margin for futures in a big way last year…

Yes, for the futures, the margins were increased from 4 per cent to 8 per cent. The reason is that between June and September last year, huge speculative activity was taking place in the market that took the dollar to a high of 69 to the rupee.

The second reason is the arbitrage opportunity that was available with the Non-Deliverable Forward (NDF) market that gave 2-3 per cent profit without any risk.

So, the RBI had no other choice but raise margins. But once the market settles down, they might bring margins down back to 3-4 per cent. This did impact volumes, but only the large systematic speculators who drive the market in one direction moved out. The normal retail speculators who trade are still there.

Who are the systematic speculators?

Foreign banks and foreign fund houses that can easily bring money into India were the systematic speculators who were doing this arbitrage. To control this, the RBI has put restrictions on them.

After September, the RBI moved the banks out of the futures too. It is a good move by the RBI from the point of view of a retail participant because there will be low volumes, but there will be no speculative activity and volatility. The spread between the NDF and online market has declined now with a one or two paise variation. This has reduced the opportunity for arbitrage now.

 Your quick view on the rupee before and after the elections…

Rupee should start weakening again now before the elections end. The huge FII flows into the country now is not because of improving Indian economy or election expectations, it is because India is considered a safe haven among emerging markets.

Once the Russian crisis settles down, FIIs might pull out money from India and invest in Russian markets which might be down about 20 per cent by that time. FII pull-out may start by mid-April as they might not wait to see the election results. And the market is likely to come down 7-8 per cent after that. So, as a result, the rupee could weaken to mid-62 or 63 levels.

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