Cashing in on currency

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Forex reserves up $1.52 billion

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As a banker with a nationalised bank explains, “Banks have to undertake a lot of documentation work to determine whether the company is in a position to settle the contract or not. In short, there is a settlement risk involved, which has to be mitigated for the process to move forward.”

But of all this is merely part of the subject as to why the introduction of currency futures is so relevant and important to corporate India. Observers say that its introduction will pave the way for the entry of the more sophisticated currency options tool in the country. By some estimates it could be as early as next year. Says Venkatesh of IDBI Gilts, “Most developed markets have moved in that manner. You’ve first had currency futures, then options.”

At the moment, Indian companies, especially the large ones, that go in for borrowings abroad have to rely on the overseas offices of foreign banks to hedge their exposure using currency options. It is, in other words, an offshore market rather than an onshore market, which makes it rather circuitous for many companies. “If currency options are permitted here, it would definitely help,” says a banker on condition of anonymity.

Worldwide, the currency options market is a fairly evolved one and for India to come to that level would take some time even if the device is introduced some time in the future here. It is, for the record, not unlike stock options. The only difference being that the underlying asset in a stock option is equity, while it is foreign exchange in a currency option. Basically, a currency option is an instrument or device that gives the buyer (of the option) the right but not the obligation to enter into a contract with a seller. So, the buyer has a downside protection against risk and an upside benefit from favourable movement of the underlying currency. Naturally, companies would want to take advantage of this, if it were introduced in the domestic market. “I see it as a matter of time before it finally is,” says the chief executive of a company. Adds Mehta of KPMG, “Futures in a sense is an intermediate solution, a middle path to a sophisticated options market on one hand and a plain-vanilla forwards market on the other.”