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Credit Policy: Rupee options set to be unwrapped

BS Banking Bureau in Mumbai

Bankers expect the Reserve Bank of India to unveil its plan for introducing rupee options in the next week's credit policy. This will give a fillip to the currency market and Indian companies will have a new instrument to hedge their foreign exchange exposures. Two working groups of the central bank have worked on the blueprint for rupee options.

Bankers also interpret the move as yet another step to broaden and deepen the foreign exchange market before full convertibility is ushered in.

The equity market has seen the introduction of options and futures in the recent past. In comparison, the currency market lacks depth and sophistication and corporates are able to hedge their risk only by booking forward covers. Once options are available, they will have greater maneuverability.

"The companies will particularly use the options for their contingent exposures which have not yet been crystallised. I personally feel that rupee options will act as a gateway to interest rate options and make the currency market more sophisticated," said a treasurer with a foreign bank.

To start with, all banks may not be allowed to trade in futures. Only those with sophisticated back offices may be allowed to deal with options, said another banker. The premiums will vary from bank to bank.

Today, when a company today sells forward dollars, it may make a notional loss if the actual depreciation of the rupee is more than what is anticipated. Once rupee options are introduced, the companies will be able to cover losses by buying parallel options.

In other words, in forwards, the loss is unlimited, depending on the movement of the currency. However, in options, the loss is capped to the extent of the premium paid to buy the product.

While the forward premium rates are uniform across the market, the options premium will vary from bank to bank, depending on their views on the currency. The rupee options will also be a new tool for the central bank, an active player in the foreign exchange market.

The RBI has been mopping up substantial amount of dollars from the foreign exchange market and the options can be used to its advantage.

So far, Indian corporations have access to derivative products like interest rate swaps. These enable them to hedge interest rate risks. However, no such product exists on the currency front.

If the RBI introduces rupee options in its mid week review on October 29, the treasury savvy companies will be better equipped to hedge themselves against currency risks.

Foreign exchange dealers feel the introduction of options will add depth to the foreign exchange market and strengthen the link with the money markets.

"Our equity market is more sophisticated and advanced than the currency markets. The rupee options will lift the currency market and bring the non-deliverable forwards market more in line with the local foreign exchange market," said a banker.

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