Don’t be damned by the dollar

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: less. Suppose the ideal price of a product is Rs100, and a buyer of a certain quantity ends up paying Rs 101 when a market order is placed. In this case, we say that there was an ‘impact cost’ of 1%. On the currency futures market on October 7, for a transaction size of $50,000, the impact cost was typically 0.02%. For a transaction size of $5,00,000, the impact cost is typically 0.05%.

These impact cost calculations are pessimistic in that they assume that a single order is placed into the market to buy at whatever price is available on the market. In my experience, I have seen that whenever an order for $5,00,000 or $10,00,000 is placed somewhere between the best buy and best sell prices, within a minute, the entire order is matched. There is a lot more liquidity in the eyeballs watching the screens as compared with the orders visible on the screen.

RBI has placed numerous restrictions against this market. The only currency pair that can be traded is the rupee-dollar rate. The only product that can be traded is futures. FIIs and NRIs are prohibited. The most damaging restriction is that the position of any one player is limited to 6% of the open interest of the market (or $5 million, in case the open interest is too small). Graph 3 shows how this position limit has grown as a consequence of the growth of the open interest of the market. While in the early days of the market, positions were limited to $5 million or roughly Rs 25 crore, the limit has now climbed to $9 million or roughly Rs 45 crore.

While this is not a useful number for the biggest corporations, there are a very large number of small and medium enterprises who face currency risk of this magnitude. The issues of high transparency and low intermediation costs are particularly important for these kinds of users, who are otherwise treated badly by financial firms in their currency hedging requirements.