Moving onshore

The task force appointed by the Reserve Bank of India (RBI) to investigate the question of offshore rupee markets has submitted its report. The provocation for the report has been the recent sharp growth, in the committee’s words, in the offshore trading volumes in the rupee non-deliverable forwards (NDF) market, “likely even beyond the volumes in the onshore markets”. It is not surprising that the RBI is concerned about this issue. Maintaining the stability of the currency is one of its duties, even if it no longer targets a particular level for the rupee. If the value of the rupee is set largely by NDF markets that operate offshore and beyond the regulations and visibility of the central bank, then it becomes difficult to either anticipate or manage major changes. There is no major issue with the currency at the moment, but the “taper tantrum” episode of 2013 showed how the RBI can find it difficult to manage volatility in the currency markets.

The report correctly notes that there is little or no way to directly influence the construction of the NDF markets offshore. The only thing that is in the power of the government and the central bank to change is domestic regulations. The committee, led by former Reserve Bank deputy governor Usha Thorat, has correctly determined these should be altered to ensure that the incentives for traders to shift offshore trading in NDFs onshore are strengthened. The committee notes “there is a trade-off between the size/prominence of the offshore market and the extent of regulations/restrictions that are placed on cross-border transactions and foreign exchange markets/participants”.

The clear implication is that the regulatory burden on transactions and participants is currently too high and irrationally structured, and they should be corrected. A growing economy with increasing linkages with the global economy requires modern tools to hedge currency risks.

It must be understood that fetishism for know-your-customer and a moral panic about round-tripping must give way to a clear understanding of how macro-economic stability requires the incentivisation of onshore trading. The committee suggests that at least exchange-traded NDFs should be permitted in the short term, though over-the-counter contracts are the eventual ideal. Definitely hedging volumes and convenience onshore need to be increased, so that legitimate hedging requirements are not taken to the overseas market.

While the committee’s recommendations on how to ensure the rupee can be managed with greater visibility are well meant, the fundamental need is to ensure that the macro-economic environment itself is stable enough to make these concerns redundant. India needs to keep its own house in order. Often India’s internal imbalances such as the high fiscal deficit and inflation result in external sector problems. Therefore, it is important that policymakers constantly work on strengthening macroeconomic stability. Strong and stable fundamentals would reduce the scope of speculation in the currency market.

In this context, a lower fiscal deficit and public-sector borrowing requirement will ensure that there are no concerns about debt sustainability. And real sector reforms to increase exports competitiveness will address the concerns about a high current account deficit.

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