Transactions between the rupee and a foreign currency don?t only involve spot or instant contracts. There are forwards, futures, options and swaps?these are known as derivatives because their values derive from the original spot price. Derivatives aren?t used only for hedging or risk reduction, but also for speculation and arbitrage; the last is contingent on discrepancies between spot and forward prices. Derivatives allow smooth functioning of markets?logic accepted partly for commodities and more for equity, but paradoxically, not for currency. Hence the mindset that derivative use for hedging is fine, but not for speculation and arbitrage, though it is often impossible to draw the line. Therefore, over-the-counter derivatives will be allowed, but not those that are exchange-traded. This limits availability of domestic derivative products and drives trade overseas to Dubai, Hong Kong and Singapore. Informal government-cum-RBI attempts to curb rupee trading in these places have understandably been politely rebuffed. More importantly, since not all Indian companies have overseas access, with limited products domestically, their available instruments are limited. This mattered less when exchange rates were relatively stable and less volatile.
However, the magnitude of the dollar?s hit against other international currencies was unexpected. In passing, the rupee?s depreciation against the dollar is also unexpected and is almost entirely due to RBI intervention. In 2007, many companies entered swaps to convert loans into non-dollar currencies, since interest costs were lower and profitability improved. With these contracts due to expire and exchange rates out of line with expectations, not only are companies trying to exit and cut losses, there seems to be a tacit suggestion from the government that breaching contracts is fine, since they were illegal to start with, many derivatives not being permitted. This is a specious argument and instead of proposals shuttling back and forth between North Block and RBI, it is time exchange-based currency derivatives were permitted, so as to allow Indian companies to hedge foreign currency exposures. That?s part of India?s global integration pattern, and allowing exposure to risk without allowing risk-mitigation instruments is silly. Liberalisation requires regulation. But the country is stuck in a turf battle between RBI and Sebi.
