Foreign Exchange Derivatives Market in India:

Status and prospects

Neeraj Gambhir Manoj Goel
August 12, 2002

Foreign Exchange derivatives market is possibly one of the oldest derivative

markets in India. As Indian businesses become more global in their business
approach, evolution of a broad based, active and liquid forex derivatives markets
would provide them with a spectrum of derivative products to effectively manage
their foreign exchange exposures.
In this note, we look at the evolution of the forex derivatives market in India,
study the liquidity and the depth in these markets. We also explore the hedg-
ing mechanism currently used by Indian corporates, as well as conjecture how
the hedging mechanisms might change with a continuously evolving regulatory
regime and increasing convertibility on the capital account.
Increasing convertibility on the capital account would accelerate the process
of integration of Indian financial markets with international markets. Some of the
necessary preconditions to this as suggested by the Tarapore committee report are
already being met. Increasing convertibility does carry the risk of removing the
insularity of the Indian markets to external shocks like the South East Asian crisis.
However proper management of the transition should speed up the growth of the
financial markets.
Increasing convertibility and regulatory impetus for new products will allow
introduction of a host of innovative products and structures, tailored to business
needs. The possibilities are many and include INR options, both rupee and cross
currency swaptions, as well as structures composed of the above to address busi-
ness needs as well as create real options. A further development in the derivatives
market could also see derivative products linked to commodities, weather, etc
which would add great value in an economy where a substantial section is still
agrarian and dependent on the vagaries of the monsoon.

1
The proposed structure of our paper is:

1. The need for a liquid forex derivatives market from the economic point of
view.

2. The evolution of the forex derivatives market in India.

3. The derivatives products currently available and analysis of their liquidity.

4. The proposed derivative products for introduction in Indian forex markets.

5. A roadmap for the introduction of forex derivatives products.

6. Conclusion.