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The decision to base the RBI reference rate for the rupee on actual market transactions is a step in the right direction.
It will mean that India will move away from the archaic practice of fixing the currency value based on the value given by few trading members.
Based on the recommendation of the Committee on Financial Benchmarks set up under Vijaya Bhaskar, the RBI has now said the process for setting the reference rates for the rupee against the dollar, euro, pound and yen, which is published daily at 1.30 pm, will be based on actual transactions and not on a random poll. This change will take effect from May 2.
Global fixing Earlier, prior to the onset of online electronic platforms, when trading in all markets — including gold, bonds and currency — was physical or based on open outcry system, the benchmarks were fixed daily at a particular time based on quotes given by a set of brokers or trading members.This was called the daily ‘fix’. This rate was then widely used by the market as a reference for trading and valuing securities.
While this process was acceptable when there were no electronic trading platforms, it has becomes redundant in the current environment.
A series of scandals in benchmark fixing, including the London Interbank Offered Rate fixing scandal and the rigging of WM/Reuters 4pm London fix, have increased the call for a review of the process for setting these benchmark rates. A handful of traders were seen manipulating the fixing rate or front-running in these cases.
Need for reference rate In the age of 24-hour trading in the forex market, some question the need for a central bank-determined reference rate. But other global central banks, including the European Central Bank, Bank of Canada and Central Bank of Brazil, too publish reference rates for their currencies that are used widely within and outside their countries.
The RBI reference rate is also reported to be used by companies for determining transfer pricing rate. The RBI, the Centre and the IMF also use this rate for valuing assets and liabilities.
More credibility The existing reference rate setting process for the rupee is however, more fool-proof than the processes followed in other countries.
The reference rate is published at 12.30 pm everyday. Quotes for dollar-rupee and euro-rupee are polled from a set of banks selected randomly from a large panel of banks with forex operations.
The rates are taken for a randomly selected five-minute window between 11.45 am and 12.15 pm. The random selection of time-period and banks makes it fairly difficult for anyone to manipulate the rate.
This process would now be tightened further by fixing the reference rates based on actual market transactions that will be volume weighted. That is, the rates at which higher volumes are transacted will be giver higher weights. This serves as a check for circular trading.
Other changes The RBI is also trying to broaden the participation in the forex market by authorising the setting up of electronic platforms with central counter parties that take care of settlements. Such platforms will make it possible for small companies and retail customers too, to hedge their foreign exchange exposure.
Plain vanilla currency options had fallen out of favour in forex markets after they were mis-sold by banks to small companies.
But the stringent controls on these instruments have now been removed.
Participation in rupee futures traded on exchanges will improve if NRIs are allowed to trade on these platforms.
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