Business Today

Greenback mountain

Rajiv Bhuva        Print Edition: August 7, 2011

A billion has nine zeros. Kolkata-based Amit Pansari trades $6 billion, or about Rs 26,600 crore, a year in currency derivatives between the National Stock Exchange, or NSE, and the MCX-SX. This is more than the $5.5 billion that foreign institutional investors pumped into the country this year up to July 13, 2011.

The 35-year-old Pansari's feat may boggle the mind, but he is not alone. It is speculators who drive volumes on the country's three currency exchanges today (the third is United Stock Exchange, or USE). Monthly volumes have jumped 57 per cent between January and June this year, to cross Rs 10 trillion (a trillion is 100,000 crore).

Pansari is a director of Well Made Impex, a foreign exchange advisory company whose earnings come in foreign currency, too. He uses exchange-traded currency derivatives, or ETCDs, not only to hedge foreign currency risk, but also to speculate for profit. The sum of his daily buys and sells ranges from $50 million to $100 million, and his portfolio grows more than 35 per cent every year. "Currency accounts for 75 per cent of my portfolio," he says.

The popularity of currency trading has shot up among equity derivatives traders. Chennai-based Krishna Kumar Nathani, Managing Director and CEO of IndiaBullion.com, a webbased bullion and forex advisory service, was an equities trader until commodity trading was allowed on exchanges. For a while, his portfolio was split equally between stocks and commodities, and now the allocation is 30:35:35 between stocks, commodities and currency.

When caps on NRI and FII participation are removed, trade volumes will grow manifold
T.S. Narayanasami, MD United Stock Exchange
Currency trading accounts for more than 60 per cent of global trading, and is the largest segment, followed by commodities and equity. In April 2010, Alpari India, part of the Britain-based Alpari Group, which offers online currency trading services, projected that in volume terms, ETCDs could exceed equity derivatives in India by 2012. Between January and June this year, the average daily volume for equity derivatives on NSE was Rs 129,873 crore. Daily ETCD volumes are Rs 35,000-40,000 crore.

"Commodity markets in India took more than five years to reach this volume," says Pramit Brahmbhatt, CEO, Alpari India. "The ETCD volume moves up to Rs 45,000-50,000 crore when equity markets are volatile." While high volumes indicate interest in ETCDs, what is troubling is that trading is almost totally speculative, and there is little actual hedging of forex risk.

The biggest advantage of ETCDs is price transparency. Besides, they eliminate the risk of default, as exchanges maintain a fund to guarantee trades. They are also easily accessible to all. Yet, only 10 per cent of volumes come from hedgers.

"The volumes are growing, but there's a lack of awareness," says T.S. Naraya n a s a m i , Managing Director and CEO of USE, the latest exchange to offer currency derivatives. USE accounted for 22 per cent of the market share in June 2011.

Why hedgers stay away
In India, the traditional hedge against currency risk has been forward contracts on currencies that banks sell over the counter. "The tendency is to get rates from the OTC markets, and the banks' quotes are final," says Narayanasami, who was Chairman and Managing Director at Bank of India before joining USE. The over-the-counter contracts he is referring to are customised by banks, and must be settled at a pre-determined price on a pre-determined date. ETCDs, on the other hand, are standardised trades, closed at the settlement price on exchanges.

While OTC contracts require no margins, buyers and sellers of ETCDs must maintain a margin by means of a deposit with the exchange, in proportion to the outstanding sell or buy value. ETCDs also require a daily marking to market of trade positions. "Keeping track of these is an administrative hassle that exporters prefer to avoid," says Subramanian Dhananjayan, a chartered accountant and adviser to the Forex Derivatives Consumers Forum of Tirupur.

"Banks don't charge margins, but offer clients different rates depending on their relationship and the volume," says Vivek Dave, Director at MRC India, an online currency trading service provider. "Exporters are comfortable with the arrangement with their bank," says Dhananjayan.

But, according to the Forum, Tirupur exporters lost Rs 400 crore in 2006/07 because banks sold exotic financial derivative products to exporters who did not understand them. When currencies other than the dollar fell during the global meltdown, the exporters were in trouble. Anil Bhardwaj, Secretary General of the Federation of Indian Micro and Small and Medium Enterprises, says: "Small and medium enterprises burnt their fingers in 2008/09."

Despite this, the transparency of ETCDs fails to catch the attention of hedgers. The rupee has been relatively stable since 2009, so exporters have stuck to their traditional hedge. "Education is the biggest factor," says Joseph Massey, CEO of MCX-SX.

Another reason potential hedgers stay away from ETCDs is that, while speculators square off trade positions almost daily, businesses need to keep positions open for long, which would entail administrative hassles such as marking to market. Businesses prefer to take longer positions - say, one year - depending on delivery schedules.

Since speculators, who think short-term, outweigh hedgers in ETCDs, volumes and activity in contracts up to three months are higher than for later months. "For 90 per cent of traders, contracts are active in the near months," says Nathani. Currently, non-resident Indians and FIIs cannot trade in ETCDs. "When those caps go, volumes will grow manifold," says Narayanasami.

What draws speculators

If hedgers have so much to worry about, why are speculators confident? Pansari says ETCDs are less volatile than equity derivatives. Nathani says the lack of liquidity and the securities transaction tax have killed the earnings of arbitragers in equity derivatives. Then there are transaction costs: Dave points out that a turnover of Rs 1 crore for ETCDs would cost Rs 60, but for equities it would cost Rs 1,200. While currency derivatives have attracted day traders, open interest -positions that are not squared off by the end of the day - is low. Settling daily helps traders avoid paying margins, and to have exposure marked to market, says Pansari. In a traderdominated market, he and Nathani represent a new breed of money spinners.

One needs to track macroeconomic developments. "But the market has no concerns such as insider trading or governance," says Dave. Until hedgers grasp the potential of ETCDs, it will remain a speculators' game.

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