Currency derivatives open interest rises as rupee volatility spurs hedging

Currency Derivatives

Heightened volatility in the Indian rupee in the last few months has led to an increase in open interest futures contracts in the currency derivatives market.

According to the National Stock Exchange of India (NSE) data, open interest futures contracts was 7-8 crore per month between October and February, which is the highest since May last year.

Open interest is the total number of outstanding derivative contracts for an asset—such as options or futures—that have not been settled.

An increase in these contracts signifies that as the rupee turns volatile, corporates, banks, and financial institutions are increasing their hedging activities.

“From October, open interest in futures contracts was increasing as the Reserve Bank of India (RBI) intervened heavily in the foreign exchange market by participating in NSE’s futures and non-deliverable futures,” said Amit Pabari, managing director at CR Forex Advisors.

With the rising contract volumes, the average daily turnover in the currency derivatives market also surged and remained in the range of Rs 8,000 crore to Rs 20,000 crore.

Going ahead, experts believe that if the local currency remains volatile there can be a further increase in these contracts and turnover in the currency derivatives market.

The rupee plunge

In the last few months, the rupee has depreciated sharply due to multiple geopolitical as well as internal factors such as India’s sluggish growth in the second quarter of the current financial year, widening trade deficit, rising crude prices, and a surge in the dollar index after the US Federal Reserve hinted at fewer rate cuts in 2025.

Adding to this, the imposition of tariffs on Canada and Mexico by US President Donald Trump also impacted the rupee.

According to the Bloomberg data, the Indian rupee has depreciated to 87.2025 against the US dollar as on February 26, as compared to 83.8213 on October 3, 2024.

The RBI has been intervening in the foreign exchange market by selling dollars in the spot as well as in forward markets. Data suggests that India's forex reserves have declined sharply by over $75 billion since September 27.

RBI restrictions

Open interest in contracts has been on a declining trend since last year after the RBI said that investors must have valid underlying contracted exposure that has not been hedged using any other derivative contract, and they should be in a position to establish the same if required.

The underlying in derivatives contracts refers to the order bill, or receipt, in the case of exporters and importers, or documents to support the transaction in the case of remittances.

The initial implementation date of the RBI circular was April 5, 2024, which was later extended to May 3, 2024, after concerns were raised about participation in the exchange-traded currency derivatives market.