With the Finance Minister flagging the trading of rupee derivative contracts on exchanges in the International Financial Services Centre in GIFT City in Gujarat, the RBI has begun the project of moving the large offshore market for the rupee back to India. Due to the higher restrictions on foreign investors trading in rupee forwards, and rupee exchange traded futures and options on domestic platforms, a large offshore market has developed for the Indian currency. The value of rupee derivatives traded in offshore exchanges such as Dubai, Singapore and Chicago is on par with the transactions in domestic exchanges such as the BSE, NSE and MSE. Similarly, value of rupee non-deliverable forward contacts traded in offshore centres is higher than the value transacted onshore.

With the Covid-19 pandemic disrupting all financial markets, including the forex market, it is not surprising that the RBI has finally given its nod for trading rupee derivatives in the GIFT-IFSC. The Indian rupee had declined sharply by 8 per cent in the first quarter of this year. While the currency has not lost much ground since then, it remains vulnerable due to various counts. Emerging economies are perceived to be on a weaker footing in terms of their ability to bear the additional cost of fighting the pandemic and reviving their economies, and hence are likely to witness higher foreign portfolio outflows in the coming months. FPIs have already pulled out $16.5 billion out of the Indian equity and debt market in the first four months of this year. With businesses globally in a slump, foreign direct investment flows are also likely to be scarce. The crash in crude oil, impacting the oil-producing nations, will impact inward remittances in to India. Over 40 per cent of inward remittances come from the UAE, Saudi Arabia, Kuwait, Qatar and Bahrain. With the risk of FPI outflows remaining high in the near term, the RBI cannot afford to rest easy as far as the external account goes. A report by the task force on offshore rupee markets, headed by Usha Thorat, highlighted that in periods of intense volatility in forex markets, the offshore rupee market tends to influence rupee movement in the domestic market, exacerbating the decline.

With the introduction of exchange traded derivatives on exchanges in the GIFT-IFSC, FPIs, Indian companies, IFSC banking units, trading members, global banks and custodians and NRIs can use this platform for hedging or for taking directional calls. With the transaction on the IFSC exempt from short-term and long-term capital gains tax as well as transaction taxes and stamp duty, this platform is quite competitive, compared to global offshore financial hubs. The next step for the Centre is to help increase the participation in the exchanges in the GIFT City, since foreign investors are not likely to migrate here unless the liquidity price discovery is good. This move, coupled with the permission to international banking units in the GIFT-IFSC to trade in rupee NDFs, helps begin the process of reversing the migration of rupee trades, from offshore to onshore.

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