Forex: 20 years of pride & prejudice

July 2, 1991, Tuesday. My second day at work as a rookie in the forex department of a large steelmaker in Mumbai.

The screaming headline of a business newspaper was — “Devaluation!”

The headline was repeated on Thursday, July 4. The rupee was devalued by 18-19 per cent in two steps on and July 1 and 3, 1991 from about 17.50 to about 21.90 to a dollar. The modern forex market was midwifed into existence by the dream team of C. Rangarajan, Manmohan Singh and Narasimha Rao.

Then, from 1991 to 1997 the forex market was stewarded through a process of LERMS, unified exchange rate and managed float (old timers would remember the famous 31.37 rate) and trade account convertibility into a floating rate regime by stalwarts such as O. P. Sodhani, S. S. Tarapore, Shyamala Gopinath, Usha Thorat, G. Padmanabhan and Y. V. Reddy.

It was a period of pride (and some prejudice) as the RBI won plaudits the world over for piloting India’s external sector through turbulences such as the post-Pokhran economic sanctions, the Kargil war and the Asian currency crisis.

Biggest change

The forex market has changed in many ways over the last 20 years. The biggest change is the increase in volatility from a couple of paise a day to 50 paise/day and to 230 paise/month now.

This is directly proportional to the decrease in the RBI’s ability to control the market; again directly proportional to the increase in volumes due to the greater openness of the Indian economy to global trade and capital flows.

While the daily forex turnover has increased 10-fold from $5 billion/day in 1996-97 to $52 billion/day in 2012, the gross external account has increased 12 times from $171 billion or 34 per cent of GDP in 1996-97 to $2,025 billion or 188 per cent of GDP in 2011-12.

No wonder the RBI cannot keep the rupee in check any longer.

The second biggest change is that the increased volatility and the two-way movement in the rupee have led to greater awareness of risk and greater appreciation of the need for systematic hedging among corporates, as opposed to the machismo filled speculative trading that forex risk management was equated with earlier. Keeping pace with the need to hedge has been the availability of more hedging instruments such as forwards, options, forward-to-forwards and swaps.

Of course, it is good that the appetite for mis-sold exotic derivatives has reduced due to regulation and the wisdom imparted by the School of Hard Knocks. An increase in the liquidity and price transparency for some of the instruments would now be welcome.

Talking about transparency, back in 1992-93 you could not know what the spot was if you were not a banker and banks used to capitalise on this information gap.

I remember fighting a whole day with a bank to get the correct spot rate on a $3-million deal for my employer. Thankfully, the spot and forward premia are easily available these days. But now there are problems in getting correct option prices.

That’s where banks still make money — on the information gap. By the RBI’s reckoning, 22.2 per cent of banking profit comes from forex transactions. One can safely bet that the bulk of these profits comes from scalping the “custy” rather than from taking safe bets scalping the market. That is one thing that hasn’t changed!

The emergence of Indian price quote services such as Tickerplant and Newswire 18, apart from the international offerings such as Reuters and Bloomberg, has helped in price dissemination. And, don’t tell anybody, but the Internet is also an excellent source of free and reliable price information.

These, to my mind are some of the biggest changes the market has seen. For a more rigorous and excellent account of the developments in the Indian forex market from 1991 to 2007, please read >http://rbidocs.rbi.org.in/ rdocs/publicatopnreport/ pdfs/77577.pdf .

In short, the market is bigger and better. But a lot still needs to be done. It is sad that both the RBI and the government have lost the plot after 2002.

The promised “full” and “fuller” capital account convertibility are yet to come. The rupee is not deliverable offshore and we now have the very unwelcome evolution of three-four different markets for the rupee — the onshore deliverable OTC (interbank) market, the onshore non-deliverable exchange traded (futures) market and the offshore non-deliverable OTC and exchange traded markets. Arbitrage possibilities exist between these markets that the RBI vainly seeks to plug with regulatory diktat.

Chinese strategy

This is particularly galling when one looks at China’s strategy of internationalising the yuan before allowing it to float. India has done it the other way round. We’ve floated the rupee, but have not internationalised it.

In this context, history will acknowledge the role of the DGCX (Dubai), SMX (Singapore) and MCX (India) in democratising and internationalising the rupee market and taking it out of the sole purview of the banks, while still adhering to regulatory oversight.

Jignesh Shah needs to be lauded for doing what the authorities have been too timid to do. It would now be a great step forward for India and the market if the RBI were to allow delivery against rupee futures.

But, let me end on a happy note by mentioning the stellar, but largely unsung, work of the CCIL — Clearing Corporation of India Ltd.

India is perhaps one of the few, if not the only, markets where the major portion of the OTC forex trades is centrally cleared so that participating banks do not carry counter party risk. This work is so unique that even Tim Geithner came down to study it. Take a bow, CCIL.

Twenty years is a mere blip in the life of a market. My dream is to see India as a global financial centre given that we are blessed with such a strategic geographical location that a trader can cover both the Far East and the US markets during his waking day.

(The author is Chief Currency Strategist, KSHITIJ.COM. He can be reached a >vikram@ksjitij.com . The views are personal.)

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