Even as the Indian currency lost value against the dollar over the past few weeks, the foreign arms of many Indian companies were very active in the NDF market, further pressuring the rupee's exchange rate. NDF is an outright contract in which counterparties settle the difference between the contracted price or rate and the prevailing spot price or rate on an agreed notional amount.
However, even before the slide began, RBI had issued a circular on April 25 specifying that foreign entities/structures with equity participation of Indian firms offering financial products linked to the rupee (such as non-deliverable trades involving foreign currency, rupee exchange rates, stock indices linked to the Indian market, etc) will have to take its approval. Their activities, if without the central bank's approval, would be treated as violation of the Foreign Exchange Management Act (Fema), the circular clarified.
RBI said the rupee was not fully convertible at present and such products could affect the country's exchange rate management.
Though the circular was issued three months back, its implications are sinking in only now. "By issuing this circular, RBI has essentially clamped down on the offshore rupee derivative products offered by foreign subsidiaries, which, because of equity participation from Indian companies, have an indirect currency exposure on their Indian parents," said Khaitan & Co Partner Siddharth Shah.
"By ensuring that its prior approval is required, RBI has curtailed the practice. Many of these measures also appear to have been warranted on account of high volatility seen in the rupee's value in recent times," Shah added.
While the size of the NDF market, where settlement does not take place in currencies, is not known, a BIS tri-annual survey, last published in 2010, had noted that over half ($10.8 billion) of the total rupee forward and forex swap market ($20.8 billion) was abroad. The report had also said the size of the offshore rupee market was a mere $3.6 billion in 2007.
Several entities/brokerages offer dollar-rupee swaps to foreign investors. Their Indian parents had been using those to hedge their positions in the Indian markets, putting pressure on the rupee's exchange rate. Such swaps were offered for commodities, as well as on Indian stock indices. RBI plans to discontinue such trading.
"The circular makes it very clear that foreign arms or JVs of Indian companies will have to take RBI's permission if they want to trade on NDF market. This means RBI does not want them to trade on NDF," said Mecklai Financial CEO Jamal Mecklai.
Besides NDF, RBI has also targeted financial products linked with stock indices and commodities. "Such companies cannot offer products linked with rupee-dollar trading or those on Indian stock indices listed on foreign exchanges," said Mecklai.
Among Indian indices, while the Nifty is traded on the Singapore Exchange, the Sensex is being launched on the Dubai Gold & Commodities Exchange. The Indian brokers that have made huge investments in their foreign arms would find it difficult to trade in Indian exchanges' indices. They could, however, trade or facilitate trading in indices of other countries' exchanges, such as the US' Dow Jones Industrial Average and S&P.
The RBI move has, however, created confusion for brokerages, which say they were advised when the circular was initially issued that broking was just a service, and not a product, so they need not seek RBI's permission. A senior representative of the Commodity Participants' Association of India said that the association was seeking clarification from RBI on the implications of the circular, because it talks about "facilitating trading in currencies, securities and commodities".
Since the circular intends to stop trading facilities provided by foreign firms with equity participation from Indian companies, it is feared it might have an impact on genuine hedging, too.
"There might be a need to approach RBI for permission for trades involving the rupee, even if it is for a genuine hedging against rupee exposure," said Christopher Krishnamoorthy, associate partner, Majmudar & Partners.