An internal working group set up by the RBI on greater capital account convertibility has recommended development of a currency futures exchange to improve hedging and liquidity.

The Reserve Bank of India has placed on its website the report of the panel on currency futures for public comments.  

Globalisation and increased cross-border flow of funds had raised the exposure to market risk, and hedging of such exposure had become critical, a draft of the proposals released by the RBI on its website said.

The working group was set up to suggest a suitable framework to operationalise the proposed currency futures.

The RBI had, on October 30, announced in its mid-term review of the annual policy that it would release the draft report for comments.

Based on the discussions with market participants and the experiences drawn from international exchanges, including those in the emerging markets, the group had listed various alternatives for introduction of currency futures, analysing the pros and cons of each option in the Indian context.

The suggestions also incorporate the views of the technical advisory committee (TAC) for money, foreign exchange and government securities markets.

"The need for introduction of currency futures has to be viewed in the context that wider hedging opportunities could strengthen economic agents'''' ability to cope with market-induced currency movements," the six-member working group said.

The draft said currency futures, initially for dollar-rupee contracts, "may be considered favourably."

Initially only residents may be allowed to trade rupee futures, with no quantitative restrictions, the draft said, and the market should be thrown open to foreigners in a gradual and phased manner.

Membership for trading should be divided into two types - hedgers and speculators, with foreigners allowed only to hedge - and exchanges should fix margins for these categories, it said.

Banks should be exchange members and brokers could be allowed, provided they met certain criteria. The contract size should be a notional $1,000 and the tenor could stretch out to 12 months. The minimum price movement, or tick price, must be 0.0025 rupees.

Since the rupee is not fully convertible, these contracts must be settled in cash, based on the central bank''''s reference rate on the contract expiry date.

Contracts should expire on the first working day after the 15th of every month and market hours should 10 a.m. to 4 p.m., it said.

Clearing houses could set margin requirements but the central bank should have overriding powers to introduce specific margins to prevent excessive leverage, permit participants to trade and fix position limits or other prudential limits in the overall interest of financial stability, it said.

The domestic foreign exchange market is also expanding rapidly as Indian companies do more business outside the country and the rupee has risen more than 12 per cent against the dollar this year, eroding margins for exporters.

According to the Bank for International Settlements, India''''s share of daily global currency turnover increased to 0.7 per cent, or $34 billion, in 2007 from 0.3 per cent in 2004.

India currently has rupee over-the-counter forwards, swaps and options for exchange rate hedging, but lacks a full-fledged currency futures exchange.

A rupee futures exchange that operates in Dubai since June last trades in non-deliverable rupee futures contract which settles in dollars.

Comments and suggestions on the report may be addressed to the chief general manager, Foreign Exchange Department, Reserve Bank of India, Central Office, Mumbai or through email.