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Forex market matures
January, 21st 2010

The decision by the RBI and the Securities and Exchange Board of India (Sebi) to allow recognised stock exchanges expand their menu of currency futures beyond the existing rupee-dollar pair marks a maturing of the forex market in India.

Given our growing integration with the global economy, especially the increasinglylarger share of trade in our GDP, it is essential that participants have access to a wider choice of hedging instruments that will enable them to cope with their currency risk exposures.

Exchanges will now be allowed to launch futures trading in euro-rupee , pound sterling-rupee and yen-rupee . The decision fulfils a promise by the RBI in its last monetary policy review and is expected to greatly facilitate market players hedge cross-currency risks. Today, the bulk of our trade - both exports and imports - is invoiced in dollars.

But as more of trade gets invoiced in currencies other than the dollar, market participants will look to hedge their risks directly rather than go through the indirect (and more expensive) over-the-counter (OTC) route using the rupee-dollar future and hedging against yen or euro.

If volumes on the existing, admittedly limited , currency futures market are any indication, the move should see a dramatic improvement in the depth and breadth of the market and better price discovery.

From a macro perspective, the move is significant as exchange-traded products are vastly superior to opaque OTC products. The latter, as the recent financial crisis has shown, pose a huge risk both by way of management of counterparty risk and absence of transparency.

The advantage of exchange-traded products is that they substitute a centralised clearing platform for individual counterparty risk and allow for standardised netting and margining. Of course, to the extent that it is available only for standardised products in terms of size and maturity, it may not do away entirely with OTC products.

There is also the fear, expressed in some quarters, that the shift to exchanges might result in an increase in purely speculative activities and hence might increase systemic risk. But, provided regulators do their job and dont sleep on the watch, there is no reason to fear.

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