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I am thankful to the organisers for giving me this opportunity to be with distinguished Central Bank Governors and professionals in forex business from South How to trade oil in forex india legally. Since we met last in Hyderabad a year ago, the financial world has come out of a serious crisis, perhaps wiser and more sober.
I, therefore, propose to share with you the Indian experience in the development of forex markets. A review of the status of implementation of these recommendations would provide an excellent overview of what has been achieved and what is yet to be achieved. Further, the Committee on Capital Account Convertibility, August Tarapore Committee made some recommendations on financial markets, especially relevant to forex markets, and perhaps a brief review of the current status on these would also be informative.
The significant features of our forex market are then brought out in this address. Evolving linkages between forex markets and other markets will also have to be tracked. Finally, some aspects of forex markets, especially relevant to our country such as gold import policy and flows from non-resident Indians will be explained. The address will typically conclude with a brief narration of current issues. Market players in forex became active in the seventies, consequent upon the collapse of Bretton Woods Agreement.
This perhaps marks the beginning of forex market in India. As opportunities to make profits began to emerge, the major banks started quoting two-way prices against the rupee as well as in cross currencies and gradually, trading volumes began to increase.
During the period, the exchange rate regime in India was characterised by daily announcement by the RBI of its buying and selling rates to Authorised Dealers ADs for merchant transactions. The RBI performed a market-clearing role on a day-to-day basis, which naturally introduced some variability in the size of reserves. Incidentally, certain categories of current and capital account transactions on behalf of the Government were directly routed through the reserves account.
Rangarajan provided the basic framework for policy changes in external sector, encompassing exchange rate how to trade oil in forex india legally and, current and capital account liberalisation.
The Report indicated the transition path also. Accordingly, the Liberalised Exchange Rate Management System involving dual exchange rate system was instituted in Marchno doubt, in conjunction with other measures of liberalisation in the areas of trade, industry and foreign investment. The dual exchange rate system was essentially a transitional stage leading to the ultimate convergence of the dual rates made effective from March 1, This unification of exchange rates brought about the era of market determined exchange rate regime of rupee, based on demand and supply in the forex market.
It also marks an important step in the progress towards current account convertibility, which how to trade oil in forex india legally finally achieved in August by accepting Article VIII of the Articles of Agreement of the International Monetary Fund. The appointment of a 14 member Expert Group on Foreign Exchange Sodhani Committee in November was a follow up step to the above measures, for the development of the foreign exchange market in India.
The Group studied the market in great detail and in its Report of June, came up with far-reaching recommendations to develop, deepen and widen the forex market as also to introduce various products, ensure risk management and enable efficiency in the forex market by removing restrictions, introducing new products and tightening internal how to trade oil in forex india legally and risk management systems.
The Sodhani Committee had made 33 recommendations and of these, 25 recommendations called for action on the part of the RBI. RBI has accepted and implemented in full or to some degree, 20 out of the 25 recommendations. In the process, the banks have been accorded significant initiative and freedom to participate in the forex market.
Corporates also have been accorded noticeable freedom to operate in the forex market. Thus, they are permitted to hedge anticipated exposures though this facility has been temporarily suspended after the Asian crisis. They were given freedom to cancel and rebook forward contracts, though currently due to the Asian crisis effect, freedom to rebook cancelled contracts is suspended while rollover is permissible. Banks can, however, offer how to trade oil in forex india legally options on back-to-back basis.
Corporates can also avail of lower cost option strategies like range forwards and ratio range forwards and others as long as they do not how to trade oil in forex india legally up as net writers of options. Also available are some degrees of freedom to manage exposures in External Commercial Borrowings without having to approach authorities for hedging permission, and to access swaps with rupee as one of how to trade oil in forex india legally currencies to hedge longer term exposures.
The Committee recognised that improvements in internal controls and market strategies go hand in hand with liberalisation and towards this end, RBI accepted and implemented several suggestions of the Sodhani Committee. Recommendation on publishing critical data on forex transactions, has been implemented, and in fact the standards of disclosure by RBI are considered to be very high now.
A few recommendations of the Sodhani Committee which have not been implemented include, inducting Development Financial Institutions DFIs as full-fledged Authorised Dealers ADssetting up a forex clearing house, legally recognising netting of settlements, permitting corporates to undertake margin trading and setting up of off-shore banking units in Mumbai. Let me briefly dwell on each of these issues. Induction of DFIs as full-fledged ADs is linked to future role of development financial institutions and indeed the approach to universal banking.
Till then, their activity in the forex market can only be incidental to what they are permitted to do as a DFI. The position on setting up of a Forex Clearing House and the position on setting up of off-shore banking units will be detailed in the latter part of this address. Margin trading by its very nature is considered to be potentially speculative, and therefore, has not been seriously considered so far for implementation. Tarapore Committee on Capital Account Convertibility,had recommended a number of measures relating to financial markets, especially forex markets.
Some of the measures undertaken in regard to forex may fall short of the indicative quantitative limits given in the Report, but the purpose and the spirit of such measures are in line with the recommendations of the committee. In respect of the recommendations of the Committee to develop financial markets also, significant progress has been made. In the money market, as part of improving the risk management, recently, guidelines for interest rate swaps and FRAs have been issued to facilitate hedging of interest rate risks and orderly development of the fixed income derivatives market.
Measures have also been undertaken to further develop the Government securities market. Permission has also been given to banks fulfilling certain criteria to import gold for domestic how to trade oil in forex india legally. As will be explained later in this address, this aspect of gold policy is a major step in bringing off-market forex transactions into forex markets by officialising import of gold.
There are several features of Indian forex market which, even if well known, require to be recalled comprehensively. Major public sector units, corporates and other business entities with foreign exchange exposure, access the foreign exchange market through the intermediation of ADs.
The foreign exchange market operates from major centres - Mumbai, Delhi, Calcutta, Chennai, Bangalore, Kochi and Ahmedabad, with Mumbai accounting for the major portion of the transactions. Foreign Exchange Dealers Association of India FEDAI plays an important role in the forex market as it sets the ground rules for fixation of commissions and other charges and also involves itself in matters of mutual interest of the Authorised Dealers.
Of late, the Foreign Institutional Investors FIIs have emerged as a major component in the foreign exchange market and they do account for noticeable activity in the market. The foreign exchange market can be classified into two segments. At present, there are over ADs operating in the foreign exchange market.
The banks deal among themselves directly or through foreign exchange brokers. The inter-bank segment of the forex market is dominated by few large Indian banks with State Bank of India SBI accounting for a large portion of turnover, and a few foreign banks with benefit of significant international experience.
In the inter-bank market, SBI along with a few other banks may be considered as the market-makers, i. The market makers are expected to make a good price with narrow spreads both in the spot and the swap segments. The efficiency and liquidity of a market are often gauged in terms of bid-offer spreads.
Wide spreads are an how to trade oil in forex india legally of an illiquid market or a one way market or a nervous condition in the market. In India, the normal spot market quote has a spread of 0. At times of volatility, the spread widens to 5 to 10 paise. The turnover in the Indian forex market has been increasing over the years. The forward how to trade oil in forex india legally in our country is active up to six months where two way quotes are available.
As a result of the initiatives of the RBI, the maturity profile has since recently elongated and there are quotes available up to one year. In India, the link between the forward premia and interest rate differential seems to work largely through leads and lags. Importers can move between sight payment and days usance and will do so depending on the overseas interest rate, local interest rate and how to trade oil in forex india legally on the future spot rate.
Similarly, importers can move between rupee credit and foreign currency credit. Also, the decision, to hedge or not to hedge exposure depending on expectations and forward premia, itself affects the forward premia as also the spot rate. Exporters can also delay payments or receive funds earlier, subject to conditions on repatriation and surrender, depending upon the interest on rupee credit, the premia and interest rate overseas. Further, banks were allowed to grant foreign currency loans out of FCNR B liabilities and this too facilitated integration as such foreign currency demarcated loans did not have any use restriction.
This decision also affects the premia. Gradually, with the how to trade oil in forex india legally up of the capital account, the forward premia is getting aligned with the interest rate differential. However, the fact remains that free movement in capital account is only a necessary condition for full development of forward and other forex derivatives market.
The sufficient condition is provided by a deep and liquid money market with a well-defined yield curve how to trade oil in forex india legally place.
Developing a well integrated, consistent and meaningful yield curve requires considerable market development in terms of both volume and liquidity in various time and market segments.
No doubt, the integration between the domestic market and the overseas market operates more often through the forward market. The RBI publishes daily data on exchange rates, forward premia, foreign exchange turnover etc. The movement in foreign exchange reserves of the RBI on a weekly basis are furnished in the same publication. Way ahead of many developing and industrial country central banks, the RBI has been publishing the size of its gross intervention purchase and sale each month and its net forward liability position.
Since the introduction of the reform measures, broad segments of how to trade oil in forex india legally market, viz. The markets have become inter-linked to the extent participants can move freely from one market to another. The linkages between the forex market and domestic markets essentially depend on the foreign currency liabilities and assets banks can maintain and the extent and degree to which they are swapped into rupees and vice versa.
These funds can be used either for raising rupee resources through swaps or for lending in foreign currency. A significant step was taken by the RBI when it allowed banks to lend in foreign currency to companies in India for any productive purpose without linking to exports or import financing. This effectively meant that companies had the choice to borrow either in foreign currency or rupees depending on the cost, taking into account both exchange risk and interest cost.
Thus, companies can substitute rupee credit for foreign credit freely. Similarly, exporters also have the ability to substitute rupee credit for foreign currency credit.
The integration of foreign exchange market with other markets like money market and government securities market meant closer co-ordination of monetary and exchange rate policy.
For instance, in Januarywhen the foreign exchange market came under severe pressure, Reserve Bank of India undertook strong monetary policy measures leading to sharp withdrawal of liquidity and increase in short-term interest rates. The impact of monetary management was such that by February orderly conditions were restored in the forex market and normalcy was attained in money market. At times of highly speculative exchange rate movements, simultaneous intervention in foreign exchange and domestic market is called for to have an immediate strong effect on both the exchange rate and money market conditions.
Thus, to maximise the effectiveness of the foreign exchange market intervention as a signaling device, it is also carefully co-ordinated with monetary management. These co-ordinated intervention strategies require close day-to-day monitoring of the supply of how to trade oil in forex india legally system liquidity and an active use of open market operations to adjust liquidity conditions.
However, driving a wedge between money and forex markets at times, becomes necessary when it is felt that liquidity conditions may put pressure on the forex market, while tightening liquidity could hurt the real sector. The recent initiatives of RBI to usher in the rupee interest rate derivatives should facilitate the development of rupee term money market and define the rupee yield curve across maturities. Besides bringing about greater integration of the money and forex markets, the move has set the stage for the take-off of rupee-foreign currency derivatives.
Liberalisation of gold policy had an indirect but, significant impact on the forex market. The logic behind the changes in the gold policy was explained in my earlier speeches on the subjects of capital flight and gold.