Indian corporations will soon have a new instrument to hedge their foreign exchange exposures against: rupee options. The Reserve Bank of India (RBI) is giving final touches to the blueprint for rupee options.
Bankers expect the RBI to unveil its plan for rupee options in the credit policy in October. Companies now have access to derivative products such as interest rate swaps which enable them to hedge interest rate risks. However, there is no such product on the currency front. The rupee option will better equip them hedge against currency risks.
"What we have today in the currency market is futures. We can hedge the risk by booking forward covers. But once options are available, we can have greater manoeuvreablity. The introduction of rupee options will lend a lot of flexibility to corporate treasury management," pointed out a corporate treasurer.
Unlike in the equity market which witnessed the introduction of options and futures in the recent past, options in the foreign exchange market will have to be backed by underlying transactions because the RBI does not allow punting on the currency. Companies are allowed to cancel forward contracts and rebook them so long as they are backed by underlying transactions.
Foreign exchange dealers feel the introduction of options will add depth to the foreign exchange market and strengthen the link with the money markets. It will also bring the non-deliverable forward (NDF) market more in line with the local foreign exchange market.
"When a company today sells a six-month or one-year forward it may end up losing because the actual depreciation of the rupee may be more than what is anticipated. But once this instrument is introduced, companies can cover losses by buying parallel options," said a senior banker.
In other words, in futures, the loss is unlimited, depending on the movement of the currency. However, in options, the loss is capped to the extent of the premium paid to buy the product. While the forward premium rates are uniform across the market, the options premium will vary from bank to bank, depending on their views on the currency.
"All banks may not be allowed to trade in futures. To start with, those with sophisticated back offices may be allowed to deal with options," said another banker. The premims will also vary from bank to bank.
The introduction of rupee options will also offer a new tool to the central bank which has been an active player in the foreign exchange market.
"The RBI has been mopping up substantial amount of dollars from the foreign exchange market. It will be able to use options to its advantage," an RBI official said. Bankers also interpret the move as yet another step to broaden and deepen the foreign exchange market before full convertibiliy is ushered in.
