Friday, July 01, 2011

India is losing the market for trading the Indian rupee

The recent order by the Competition Commission of India on NSE and MCX-SX has a bunch of difficulties based on a lack of understanding of new age industries where a pricing of zero is quite feasible and important, a focus on protecting a competitor instead of upholding competition, etc. I wrote about this in the previous blog post.

The most important problem with this order is that it represents a diversion away from the real story. The real story is that trading in the Indian rupee is leaving India.

The rupee is traded on three venues:
  1. The onshore exchange-traded market (NSE, MCX-SX, USE)
  2. The onshore OTC market
  3. The offshore OTC market (which is called the `non-deliverable forward' or NDF market).
In an article in the Business Standard today, Jamal Mecklai says:
in April 2011, NDF volumes, at nearly $43 billion a day, were more than double those of the onshore OTC market (about $21 billion a day), and nearly 40 per cent higher than the combined OTC and futures onshore volume. Clearly, the bulk of price discovery for the Indian rupee has migrated offshore.
While we are bickering about the valuation of one player in the onshore exchange-traded market, we are losing the plot. The real story is that India is losing the market where the rupee is traded. While we are fussing about NSE's charges on the currency futures market, the OTC market offshore charges zero and has steadily gained market share.

This is part of a larger concern which needs to be more carefully considered. As India internationalises, domestic customers of financial services, and the foreign order flow, will increasingly shift their business to providers abroad when there are problems in the local financial system. These problems fall into three kinds:
  1. Non-residents do not like to send orders to India given that India as yet lacks a residence-based taxation framework; they would rather send their orders to Singapore or Dubai or London which do.
  2. Indian capital controls hinder orders from non-residents: E.g. RBI prohibits FIIs from trading on the exchange-traded currency futures market (the only edge that India has in the trading of the rupee).
  3. An array of mistakes in regulations in India hinder the emergence of a capable domestic financial system (e.g. the CCI order, prohibition of options trading on INR/EUR, mistakes in how RBI will compute the INR/USD reference rate which must be used in the functioning of the exchange-traded contracts, etc.)
Our mistakes in policy on these three fronts generate a genuine possibility of a hollowing out of the domestic financial system in coming years.

The overseas market is the real source of competitive pressure. Unless overturned, the CCI order is working to reduce the market share of the onshore market.

Financial policy has two goals in this field. First, we'd like for more business to be on the transparent exchanges instead of the OTC market. This goal is assisted by a price of zero at exchanges. Second, we'd like for more business to be in India rather than the overseas market. This goal is also assisted by a price of zero at exchanges.


  1. We have lost the plot even when the pricing of zero on currency derivatives was in place.

    Besides, these two markets are not so fungible except for foreign players.

    What's more, Mr Mecklai points out that a major part of the variations take place in markets in other time zones during the time when Indian markets are closed.

    You have also rightly pointed out other factors why business is going away from Indian markets (no residence-based tax framework. So I do not think the CCI's decision has or will have any impact on this megatrend.

    Rupee trading on other markets does not necessarily mean that trading in local markets is shrinking. In other words, the cake is enlarging, but our slice isn't necessarily contracting, I suspect.

    More trading of the rupee in foreign markets could be seen as another tacit form of acknowledging India's importance in the global marketplace.

  2. Hi,
    Sorry for my ignorance, but can you clarify whether cross-currency futures trading in OTC is legal as per RBI or not.
    Circulars on 1Feb2011 and 1July2011 seems to be in conflict on this matter.


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