If wishes were horses

ANNUAL POLICY 2005-06

Acknowledging the fact that Indian markets are now open enough to where global winds will continue to drive volatility higher, Reserve Bank of India has decided to make the monetary policy announcements quarterly (from the current half-yearly).

While this is excellent, it will be of precious little value to users of our markets unless they are also provided with additional tools with which to manage risk and greater freedom to pursue trading profits.

Thus, here is a wish list - a beggar's banquet for the next monetary policy.

To absorb the higher volatility, we need to deepen and widen the domestic forex market.

This will best be accomplished by permitting companies that actually carry rupee/US dollar risk - for example, companies who buy (or sell) petroleum products or other commodities (such as copper or aluminium) that are priced on an import parity basis - to access the domestic market to hedge their risk.

This will go a long ways to enabling companies to further increase their efficiencies by improving their risk management. Equally, this is only fair - it is ludicrous that a company like, say, Jet Airways, can hedge the forex (and commodity price) risk on jet fuel that they buy in London, but not on fuel that they buy from Indian Oil or HPCL or BPCL in India.

Equally, the oil companies cannot hedge their domestic sales against possible rupee appreciation.

With the huge amounts of utilisation of petroleum and downstream products, not to mention myriad other domestic sales that are priced on import parity, this would dramatically increase the "merchant" side of the domestic forex market.

Of course, increasing the underlying is simply the first step. Currently, the Reserve Bank of India (RBI) is proud of the fact that the inter-bank market trades at 2.7 to 3.7 times trade underlyings, to judge from their tone; global markets trade at 80 to 100 times trade underlying.

Clearly, we are a long, long way from global conditions as far as market liquidity goes.

Perhaps most disconcertingly, the RBI does not seem to be aware of this.

It needs to set up an action committee, which is mandated to assess the progress of market deregulation and report on a six-monthly basis - or better yet, at each quarterly monetary policy review - with recommendations for further changes that may be needed.

Companies should be permitted to sell (as well as buy) currency options - in other words, companies should be able to receive premium on an option contract. This will not only have the effect of providing companies more flexibility to manage risk, it will also bring myriad structured products being offered into the ambit of the rules.

Secondly, companies should be permitted to buy derivatives on derivatives; this will eliminate the untoward situation under current rules, where a company who swaps a rupee loan into dollars is only permitted to reverse the swap rather than managing its risk more effectively by buying FRAs.

Again, taking cognizance of accounting rules (specifically AS11), the RBI should permit companies to have a separate limit for hedging translation risk, which now flows through their income statements.