Rupee Matters

CONTEXT

Over the past few years, there has been a concern over the sharp rise in offshore rupee trading volumes.

Facts

Data from the Bank of International Settlements pegs daily offshore rupee trading at around $16 billion in 2016, almost equal to onshore trading.

Recent data from the Bank of England pegs offshore rupee trades at $23 billion in 2018.

Challenges

Which forces determine the rupee’s value?
What is the ability of the central bank to ensure “currency stability”?
Offshore markets allow participants to trade in non-convertible currency. These markets have evolved for currencies where restrictions are imposed in domestic markets on foreign exchange convertibility.
The constraints on foreign participation in domestic currency markets stem from cumbersome documentation and KYC requirements, restrictions on products, and inconvenient trading hours. These restrictions push investors into the trade offshore markets to hedge their currency risks.
These markets have begun to play a critical role in “price discovery”, more so during “periods of uncertainty” like the taper tantrum in the 2013 and 2018 emerging market crises — when the offshore market was driving the onshore exchange rate. This has reduced the efficacy of foreign currency intervention by the central bank.

Recommendations

Incentivize market participants to shift to onshore markets, by extending onshore market hours, and examining issues of taxation.

Allowing market participants to take exposure up to $100 million, without any need to establish the existence of an underlying risk

Incentivize greater participation in rupee-denominated bonds

As the economy grows, expand onshore currency markets in a calibrated manner

The ability to hedge currency risks will increase the rupee’s attractiveness for trade invoicing and portfolio diversification

This can lead to the gradual internationalization of the currency.

Source: Indian Express

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