Column Futures coming soon, to NSE

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: Exchange-traded currency futures is the first building block of the bond-currency-derivatives nexus, and the first important accomplishment of the UPA in financial sector reforms. Despite five mistakes in the launch, it could be bigger than Nifty futures.

With globalisation, the Indian economy is littered with currency risk, often in unexpected places. A key driver is ‘import parity pricing’. For example, the domestic price of copper is now defined by the global price of copper. When the rupee depreciates by 1%, the domestic price of copper goes up by 1%. A buyer of copper is thus exposed to currency risk—even if he is buying domestic copper. The producer of copper is also exposed to currency risk—even if he is selling to a local buyer.

Infosys is an export-oriented company. An analysis of the historical data shows that, on average, a 1% depreciation of the rupee generates a 1.1% rise in the price of Infosys shares. Thus every Infosys shareholder, and every Infosys employee with stock options, is carrying currency risk.

All these kinds of risk can be managed using exchange-traded currency derivatives. We are used to the Nifty futures, which cash-settle to the Nifty level on expiration date. In identical fashion, currency futures cash-settle to the exchange rate on the expiration date. It is easy for exchanges, brokerage firms, and investors to integrate currency futures as one more product into the existing exchange-traded derivatives business. This launch marks the first opportunity for the dynamic non-bank financial firms of India to enter the bond-currency-derivatives nexus, which has so far been preserved as a club of the banks and PDs.

The government is to be commended for having got the right institutional structure: exchange-traded currency derivatives have been squarely placed with the stock exchanges, with regulation by Sebi. This makes sense, since there is no real difference between currency futures and Nifty futures. All manner of derivatives are securities, and their regulation should move to Sebi.

Setting up a currency futures market, as a preamble to greater currency flexibility, is the right foundation for strengthening the ideas and execution of monetary policy. Instead of the government holding out an umbrella protecting the entire country from rain—by running a de facto pegged exchange rate (at enormous cost to the country as shown by the recent inflationary spiral)—each person should be buying an umbrella that is appropriate for himself.