India Forex - Forex Trading in India

India Monday 16 November 2009 : At a time when the world is witnessing constant currency fluctuations, non-resident Indians (NRIs) and overseas investors, along with Indian residents, may look forward to some help in managing their exchange rate risks.

India’s central bank, the Reserve Bank of India (RBI), has announced draft guidelines on over the counter (OTC) foreign exchange derivatives and hedging commodity price risk and freight risk overseas.

According to the RBI’s guidelines, the products that can be used for hedging exchange rate exposures include forward foreign exchange contracts, cross currency options (not involving rupee), foreign currency-rupee options and foreign currency-rupee swaps.

RBI has also permitted banks to hedge for the purposes of managing of assets and liabilities, hedging of gold price risk and hedging of currency risk on capital.

Speculating and Hedging are the two primary ways in which forex derivatives are used. ‘Hedgers’ use forex financial contracts futures to help eliminate or reduce risk by insulating themselves against any possible future price shifts. In contrast, speculators want to take risks in order to ensure a profit.

A person resident outside India may enter into a foreign exchange derivative contract with a person resident in India in accordance with certain regulations to hedge an exposure to risk in respect of a transaction.

A non-resident Indian or Overseas Corporate Body may enter into forward contract with rupee as one of the currencies, with an authorised dealer in India to hedge; the amount of dividend due to him/it on shares held in an Indian company; the balances held in Foreign Currency Non-Resident (FCNR) account or NonResident External Rupee (NRE) account, the amount of investment made under portfolio scheme in accordance with the provisions of the Foreign Exchange Regulation Act, 1973 or under notifications issued thereunder or is made in accordance with the provisions of the Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India) Regulations, 2000 and in both cases subject to certain terms and conditions

Individuals can use these products to hedge exchange rate risk in respect of the market value of overseas direct investments (in equity and loan) and exchange rate risk arising out of trade transactions.

Individuals can also manage or hedge their foreign exchange exposures arising out of actual or anticipated remittances, both inward and outward, by booking forward contracts, without production of underlying documents, up to a limit of $100,000, based on self declaration, said RBI. While customers can buy put and call options, banks can offer only plain vanilla European options.

The RBI has allowed banks to offer plain vanilla cross-currency options to people who reside in India but want to transform their rupee liability to a foreign currency liability.

The RBI has proposed that importers and exporters having underlying unhedged foreign currency exposures in respect of trade transactions, evidenced by documents like firm order, letter of credit or actual shipment, may write plain vanilla standalone covered call and put options in cross currency and receive premia.

Since importers and exporters are being permitted to write covered call and put options both in foreign currency, rupee and cross currency and also receive premia, the facility of zero cost structures or cost reduction structures is being withdrawn, the RBI said. The central bank has also said banks can hedge their risks arising out of movement in gold prices, currency, assets and liabilities. Banks having adequate internal control, risk monitoring and management systems, mark to market mechanism are permitted to run a foreign currency-rupee options book, subject to prior approval from the RBI, it said.

Banks and companies can cancel and rebook their forward contracts, provided they give their exposure information. Banks can only offer plain vanilla European options, while companies can buy call or put options, it said.

Companies cannot undertake swap transactions involving upfront payment of rupees or its equivalent to hedge their long-term foreign currency borrowings, the RBI said. To hedge external commercial borrowings, companies can undertake swaps of interest rate, cross currency and coupon, options and forward rate agreement. Foreign institutional investors and companies having foreign direct investment can hedge their currency exposures through forwards and rupee.

Currently, the Foreign Exchange Derivative Contracts are governed by Foreign Exchange Management (Derivative Contracts) Regulations, the directions issued by the Reserve Bank from time to time and the comprehensive guidelines on derivatives issued by the Department of Banking Operations and Development.

RBI says the draft guidelines have been prepared after an internal group reviewed the existing guidelines on foreign exchange and commodity and freight derivatives overseas in the light of the developments in the domestic and international financial markets and based on the feedback received from banks, market participants, industry associations and others.