If we were to lift our heads from the exciting drudgery of the here and now, and look, for a moment, at Indian financial markets ten years hence, we would see some amazing things.
Most of the recommendations of the committee on turning Mumbai into an international financial centre would be in place. There will be a deep and liquid money market with a sound benchmark yield curve, corporates will be using the bond market much more for raising capital, derivatives and structured products will be everywhere, the rupee will be largely convertible and markets will be regulated by a single FSA-type regulator. Mumbai - indeed, India - would be much slicker, with GDP per capita (at over $3,000) more than three times what it is today.
A lovely image, and, make no mistake, it's as close to a sure thing as you can get, since it is obvious - from the recent paroxysm in inflation, followed by the trauma in the forex market - that control processes have run their course and, appearances notwithstanding, the Indian economy is being run largely by the free flow of capital. Hallelujah!
The increasingly aggressive bleating we are hearing about the strength of the rupee is clearly coming from sources that don't recognise this. In fact, there are few (including the bleaters) who doubt that over the medium term - certainly, ten years on - the rupee will be even stronger than it is today.
There will be volatility, of course, but this is the oxygen of efficient markets, and it is more than time that the regulators allowed us out of the incubators we have been trapped in for too long.
Large players, of course, have already broken out - the Tata group, for instance, has 60 per cent of its revenues from global operations, as a result of which it is much better insulated from the stronger rupee.
In the home textile sector, the four or five major players, who share about half the market, are still doing fine because they have (a) already invested in scale and quality, as a result of which they do have some negotiating power, and (b) reasonably strong risk management processes.
It is only the myriad smaller players that are hurting badly. Clearly, the RBI's increasingly unsuccessful efforts to control the financial environment are most negatively affecting only the smaller among us.
The good news is that the RBI is once again moving in the direction of further financial market deregulation. There are several committees working on different aspects of this next stage of deregulation.
In particular, there is an internal RBI committee assessing how to - note, and this is very heartening, not "whether to" but "how to" - go about setting up rupee futures.
This is a critical move for several reasons. First of all, currency futures provide a halfway house to capital account convertibility. It is clear from the way the volatility of the rupee has been jumping around that risk management, which is one of the primary roles of a market, is becoming extremely difficult.
The basic problem, of course, is that the forex market (like all our markets) is unidirectional - everybody has the same view at a given point in time. The only way to change this is to widen the participation. The simplest step would be to just declare open season and allow anybody to access the spot rupee market. But, this would be, even in my view, too big a mouthful.
Rather, permitting the existing derivative exchanges to offer rupee futures contracts would be a good way to start creating a broader spectrum of participation. While this may not change the unidirectional nature of the market immediately, it would create some divergence, and, importantly, managing this wider market would enable the RBI to develop some comfort before taking the inevitable larger plunge.
Anyone who is currently permitted to access any market in India should be permitted to use rupee futures.
This would provide value to individuals (who may wish to punt on the rupee), SMEs (who may have difficulty with bank limits and bank interfaces), companies who have economic exposures (which cannot readily be hedged with their bankers under existing RBI regulations), primary dealers and other financial intermediaries who are currently disadvantaged against Authorised Dealers, who can arbitrage across one additional (forex) market, and foreign investors who may wish to hedge their contingent returns.
In terms of impact, rupee futures would squeeze the arbitrage between the forex forwards and the domestic money market, creating a more stable yield curve. Additionally, the increased liquidity would help control spikes in volatility in the exchange rate and interest rates.
For market users, it would create greater transparency in pricing, increase the liquidity in derivatives and, for investors, enable the development of new investment avenues.
It is crucial, of course, that the launch should be successful and this will require close interaction between the RBI and the other market regulators (both Securities and Exchange Board of India and the Forward Market Commission).
In my view, this may provide one of the biggest benefits, since it will begin a move towards unified market regulation, which is widely acknowledged as one of the reasons for the increased efficiency of UK financial markets relative to those in the US. More efficient markets, of course, lead to lower borrowing costs for everybody.
1-2-3-. . . let's go!
The author is CEO, Mecklai Financial.
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