The recent reintroduction of interest rate futures (IRFs) is a significant step towards developing the debt market in India, says rating agency CRISIL.
It said t that interest rate futures (IRFs) will provide financial market participants, particularlyprimary dealers (PDs), with a superior tool to manage interest rate risks, and thereby, support theirearnings profiles over the medium term. In addition, the use of IRFs will eliminate credit and settlement risks, cut transaction costs, and enhance transparency in the debt market.
The profitability of PDs has always been vulnerable to volatility in interest rates. On account of lack of adequate tools to hedge against increasing interest rates, the PDs have had to reduce portfolio size to contain losses in recent years.
Says Suman Chowdhury, Head, Financial Sector Ratings, CRISIL, ''We believe that the PDs can reduce volatility in earnings more effectively using IRFs than by using hedging tools currently available to them.''
PDs have used swaps as a hedging mechanism in the past, though their use has been restricted owing to the limited number of counterparties, volatility in volumes, and issues relatingto procedure and compliance.
Other hedging mechanisms, such as short-selling of government securities (G-secs) in the cash market, and in the 'when-issued' market introduced by the ReserveBank of India, have also had limited success.