Thursday, May 14, 2009

“Currency futures have boosted commodity trading”

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Impact of currency futures is felt immediately as the three national online exchanges surpassed a combined peak daily turnover of Rs.3,000 crore within four months

V. SHUNMUGAM, CHIEF ECONOMIST, MCXWhile accelerating the process of economic growth and development of nations, globalisation has also exposed stakeholders in international trade to risks associated with global events. The western economic turbulence is sending shivers across domestic markets, virtually worldwide, reflecting in high volatility in the prices of goods and services.

What soon dawned upon the major economies is the thought that derivative instruments are the answer to such risks while markets become transparent and efficient empowering stakeholders. As these instruments are capable of helping the stakeholders efficiently mitigate risks, the large economies are fast resorting to exchange-traded derivative markets.

In addition to its risk-managing capability, exchange-traded derivatives across asset classes have also proved to be a stabiliser of price volatility in developed markets. The process of ‘price discovery’ that happens through convergence of information coming from a large number of heterogeneous participants on the exchange effectively does the same. The Indian government too gave its go-ahead for futures trading in a range of commodities in the local markets in 2002. The entire domestic commodity derivatives ecosystem has grown organically at a phenomenal pace ever since.

Although commodity futures bestowed immense benefits to the economic stakeholders in India, with currency futures yet to get the government nod till late 2008 it remained inadequate for all the traders dealing in global commodities. Rising volatility in exchange rates hurt competitiveness of Indian exporters and importers in an increasingly cost-conscious international market. And in a scenario where currency risks crossed national borders rapidly, an Indian exporter, despite being cost-competitive, was at a risk because the local currency could appreciate sharply from the very time he signed the contract to when he received the payment. The only option left for exporters and importers was to hedge their currency risk by widely using inter-bank OTC markets even though they were costlier, inefficient, plagued by non-transparency, scale effect, homogeneity of players, and last but not the least limited accessibility. Moreover, as global commodities constitute the bulk (80%) of the turnover of the Indian derivatives market, it was necessary that the commodity players were allowed to participate to send out the rich information of the real sector they carried for the market to discover the right exchange rate. So, currency futures had become a must in India.

In such a scenario, the government’s permission to start currency futures in India last year was a welcome step in linking the financial sector with the real (read: commodities) sector of the economy. The long-felt vaccum of currency derivatives as a risk management tool got immediately reflected: the three national online exchanges surpassed a combined peak daily turnover of Rs.3,000 crore in January within four months of starting currency futures. And it is hoped that growing participation and turnover in exchange-traded currency futures would justify the long-felt demand for this instrument in India, especially commodity-based companies, importers, and exporters in the SME segment who were so far at the receiving end in the OTC markets. Taking the SME segment participants closer to the commodities ecosystem via these currency futures would not only connect the segment of the financial markets to the real sector but also help equitably deliver the benefits to all the players.

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Source : IIPM Editorial, 2009

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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