Budget 2021 sops likely to bring rupee trading from offshore to GIFT

Foreign banks at IFSC likely to focus on non-deliverable forward business, say experts

The non-deliverable forward (NDF) market is expected to get a boost and gradually shift to GIFT City-based International Financial Services Centre (IFSC) with the Union Budget exempting overseas investors from paying income tax, if they hedge their currency risk in the form of NDF with banks set up at the IFSC.

Already, some leading foreign banks have started their business from GIFT City IFSC. Early this month, Barclays Bank received permission to start a business at IFSC. The bank had made a presentation to the SEZ development commissioner in which the NDF business was a major focus, according to a person in the know. The source also said that five more foreign banks are considering opening banking units or are in the process of getting permission.

The Union Budget 2021-22 has proposed to “insert the new clause (4E) in of Section 10 of the Income Tax Act, so as to exempt any income accrued or arisen to, or received by a non-resident (overseas investors) as a result of transfer of non-deliverable forward contracts entered into with an offshore banking unit of IFSC which commenced operations on or before the 31st day of March, 2024, subject to certain conditions.”

India has been attracting huge foreign investments (largely portfolio). To hedge currency risk, foreign portfolio investors prefer to hedge the risk in overseas NDF market, which is very liquid.

The offshore market for the rupee (INR) consists of derivative instruments in two major forms, NDF in INR and exchange-traded currency derivatives (ETCD) involving INR. While NDF is an over-the-counter (OTC) market where banks act as market makers, ETCD contracts involving INR consists of futures and options listed on exchanges. Trading in INR NDF is currently concentrated in Singapore, Hong Kong, London and New York, while rupee ETCD are listed on exchanges in Chicago, Dubai, and Singapore.

Tushar Sachade, partner, financial services, tax and regulatory, PwC, said: “The tax amendment pertaining to the exemption of income for non-resident investors from investment in NDFs issued by international banking units (IBUs) in IFSC will further push government’s agenda of Atmanirbhar Bharat.”

The tax exemption for investors would mean that they would be indifferent to buying these contracts from IBUs in IFSC, as compared to offshore branches of banks. Given that IBUs in IFSC also enjoy tax holiday for 10 years, it is likely to bring down the overall tax cost of the product and promote the issuance of NDFs from IFSC, Sachade said.

The global NDF market is estimated to be around $200 billion daily and India’s share is estimated around 18-20 per cent. So far, since May 2020 when the NDF business started at GIFT IFSC, total business has been $85 billion in nine months. The government and now the IFSCA, a unified regulator for IFSC in India, are focusing on bringing the NDF business from offshore markets to GIFT IFSC.

Prakash Subramanian, MD & head-strategy, governance & processes, Standard Chartered Bank, said: “Since allowing NDFs to be traded by Indian banks through the presence in GIFT City, we have seen spreads between DF (deliverable forwards) and NDF curves stabilise. As NDF volumes by Indian banks increase, these spreads are expected to become narrower and more stable.”

The GIFT City IFSC regulator is also pushing to bring the NDF business onshore. “Developing currency NDF market through IFSC has been one of the important policy measures of the Indian government to onshore the offshore financial services. With the recent Budget incentives, this would fast track the development of such market in GIFT City IFSC,” said Dipesh Shah, head development, IFSCA (International Financial Services Centres Authority), for GIFT City.

The IFSCA has also set up a committee early this month to position the IFSC as a global hub for rupee trading. The committee headed by G Padmanabhan, former executive director, Reserve Bank of India will submit the report in three months. The committee will include bankers and other market participants possessing expertise in clearing and settlement of derivative transactions. The committee’s mandate is to recommend specific measures to bring IFSC's regulatory and infrastructural facilities on a par with foreign jurisdictions.

Despite all these efforts, it may not be easy to bring offshore NDF businesses to GIFT IFSC. First, the proposal made in the Finance Bill is for foreign investors who are comfortable doing business with overseas branches of foreign banks. According to a senior executive of another foreign bank having a unit at GIFT IFSC: “To shift their business to GIFT IFSC, these investors also need a separate arrangement. The proposed tax changes only level the playing field for them.”

The executive adds that shifting the NDF business to IFSC is still an evolving process for foreign banks. The NDF business at IFSC will also have to be made more liquid.