CHAPTER 9
The Rupee
9.1 MARKET DESCRIPTION
The Indian rupee is not an international currency, owing to capital controls.
However, as in most countries, the currency market is one of the biggest finan-
cial markets of the country. In April 2007, turnover on the spot and forward
markets (put together) amounted to $12 billion a day.
9.1.1 THE SPOT MARKET
Rupee settlement can only be done in India, and RBI permission is required for
setting up a currency trading system. There are three currency trading systems
which have been approved by RBI: Reuters, FX-Clear (run by the Clearing
Corporation of India, CCIL), and IBS. These are interbank systems. Almost
all trading takes place in the first two. The rupee-dollar is the most traded
currency pair.
The Reuters dealing system offers a negotiation mode, in which dealers have
conversations with each other, and a computerized order matching system.
There are roughly $7 billion a day of transactions in negotiation mode and
roughly $1 billion a day through order matching. CCILs FX-Clear does roughly
$300 million a day, which is all through order matching.
As an example, on May 16, 2007, the bid-offer spread on the Reuters system
was Rs.0.01 (0.025%) for a depth of $1 million on each side. At the identical
moment, FX-Clear was offering quotes of 40.8825/40.9000, i.e., a spread of
0.043%, with a depth of $0.5 million on each side. As with the equities trading
system, FX-Clear shows a market by price (MBP) display where the top five
prices on both buy and side are displayed in real-time. The Reuters system
shows only a bid and offer with the best prices. The mean transaction size in
the overall currency market in April 2007 was $4.06 million.
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154 India’s Financial Markets
End-customers of the currency market, such as institutional investors, access
the currency market by talking with banks. Some of them are assisted in their
dealings with banks by brokers. Brokers become particularly important in
times of market volatility, when their services of identifying best-price counter-
parties are more useful. Their charges are roughly Rs.500 per million dollar
transaction on the spot market or Rs.700 per million dollar swap transaction.
Roughly 5–10% of the spot market and 20–25% of the swap market involve
brokers.
In India, the equity market sets the benchmark for transparency of financial
transactions. There is pre-trade transparency (order books are visible in real-
time) and post-trade transparency (exact transaction information is put out in
real-time). In addition, equity market intermediaries separately reveal (a) the
price at which a transaction was executed on the market as opposed to (b) the
brokerage fees charged by the intermediary.
In contrast, the Indian currency market fares poorly on all three counts. It
is highly nontransparent from the viewpoint of customers, lacking post-trade
and pre-trade transparency. This makes it difficult for customers to ensure that
they are getting best-price execution. Banks do not unbundle the price on the
currency market as opposed to their intermediation fees.
Owing to the deficiencies of the market design, currency trading is extremely
profitable for banks. Customers pay high prices for buying and get low prices
when selling. If a bank gets a buy and a sell order which it is able to serve
internally, it earns the full spread (that is shown to customers). Only the net
imbalance at a bank reaches the interbank market.
The excessive intermediation charges imposed by banks on the currency
market reach all the way to retail transactions. A traveller who seeks to buy
or sell on the rupee-dollar market faces a bid/offer spread of roughly Rs.1.50
(3.67%). As a consequence, an extensive black market has sprung up all
over the country. This involves a network of dealers who run a book on
the rupee-dollar. They offer a bid/offer spread of roughly Rs.0.15 (0.37%).
The rupee is convertible on the current account, hence this black market
is only focused on undercutting the intermediation charges of banks, and
on avoiding the constraints which prevent competing trading systems from
emerging.
Foreign investors getting involved with India would do well to be cau-
tious in how they access the currency market. One strategy that could be
used by any significant-size customer is to run an auction where ten banks
are told to send in an email with a price for a transaction of the desired size
at exactly 10
A. M. All the bidders should be told that the best price would
be chosen out of this auction at 10:01
A. M. Bidders would be able to look
at conditions on the interbank market at 9:59 and send in an aggressive

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