Shed obsession with dollar, hike exposure to euro

The US dollar’s status as the world’s reserve currency needs no reiteration. But the euro has been finding favour as a reserve currency, too. Euro holdings of central banks around the world are estimated to have gone up from 20% of the reserves to about 25% over the last two years.

No wonder Iran chose to mark its oil prices in euro some five years ago (for political or economic reasons), and achieved it fully during April 2007, given its importer base, pricing mechanism, and the inherent advantage to both itself and its oil importing partner economies.

Indeed, not many would be aware that most of the middle-eastern oil sales are concluded in the euro or the yen, on account of these countries’ trading proximity with euro or yen zones and the dollar’s slide since the start of this century.

Clearly, the euro is being increasingly viewed as a safe haven to hold on or as a better portfolio diversifier. Depending on the economic origin and the trading partners, Indian exporters of goods and services always had a choice of currency for making payments.

However, despite the fact that 90% of Indian trade is conducted with economies other than the US, Indian business had always found it comfortable to deal with the greenback due to various reasons —- mainly that there is a thriving over-the-counter forward market (and more recently, currency futures on the exchange platforms) for USD-INR pair.

To bridge the missing link in the Indian financial markets and to make accessible the benefits of exchange-traded currency derivatives to all the stakeholders of the economy, especially small and medium enterprises, the regulators allowed currency futures to be traded on the domestic exchanges last year. The trade volume (of contracts traded) on the three operational bourses surged fourfold in a span of just seven months between October 2008 and April this year.

However, in India, currency futures are currently offered only in USD-INR pair, protecting only the ones who are exposed to USD/INR volatility and enriching the dollar transactions through transparency. The stakeholders of the economy having exposure to other currencies, including the euro, are at a great disadvantage as they are not able to effectively hedge their currency risks directly on a euro-INR pair in an efficient market.

This is despite the fact that the size of their trade is much higher (16% of India’s total trade) and there are benefits of increased euro flow into the economy and particularly the corporate treasuries. 

In fact, nearly a third of the average revenue by geography of the top five Indian IT companies, which along with others constitute the backbone of our booming services industry, comes from Europe. With the total annual revenues of these companies estimated at $20 billion, this 33% works out to $6.6 billion (their euro exposure).

Additionally, for those who would want to surrogate hedge the same, there is an insignificant and negative relationship between the USD-INR and euro-INR pairs and hence it would be costlier either to surrogate hedge or to do a perfect hedge of euro-USD and USD-INR participation.

Therefore, allowing trade in euro-INR futures contract would go a long way in enabling these companies and other Indian entities to mitigate their euro risk and thus become more competent in the global market.

Many of our corporates would have opted for USD (except those who may have compulsorily transacted in euros due to origin/destination requirements) as the existing USD-INR OTC market helped them to not only plan their budgets ahead in time but also to lock their currency rates through participation, even though they could have reaped the benefits of pricing their goods or services in euros.

An exchange traded euro-INR contract would not only have helped corporate forex earners to take advantage of the strengthening trend in euro in the pre-meltdown years but also, we as a net forex holding economy, would have better diversified our portfolio in euro.

A lost opportunity it is for our forex earners and forex reserve holders. The lesson to be learnt is that a thriving market for euro-INR would have helped improve our forex earnings and manage our risks by diversifying our earnings/ holdings portfolio.

Today, many nations are moving away from chasing the greenback to park their funds. It is about time, in the interest of our corporate sector and the economy, that our regulators examined the possibility of introducing euro-INR rate contracts on the currency futures platform with separately from the USD-INR one, which is more focussed on retail clients.