The Reserve Bank of India (RBI) is said to be gearing up to initiate an interest rate futures market yet again. Will the product be a success, or will it fail like the previous attempts? The most important factor that favours success this time is Governor Raghuram Rajan. The most important factor that works against it is the old RBI mindset that fundamentally mistrusts markets.
Why might this time be different? In contrast to the earlier approach of micromanagement, Rajan’s view as indicated in the Raghuram Rajan report indicates that exchanges should have the freedom to design products. It says:
“Exchanges should have the freedom to structure products according to market needs. The issue of removal of ‘segments’ of exchanges becomes particularly important with interest rate derivatives.”
This time we may thus expect that RBI will change its policy of control and command and dictating the product it wants traded regardless of the market for it.
Second, in the past, a key method that has been used to prevent the emergence of a market has been to interfere with rules about participation. Certain kinds of financial firms are cut off from accessing the bond depository (which is run by RBI), or the CCIL, or currency futures trading, etc. This is a contrast with the strategy of the equity market, which is open to everyone. If a market has to get liquidity it needs all kinds of participants. For example, if there is demand from foreigners who are buying government bonds to hedge, then they will bring liquidity to the currency and interest rate futures markets and should be allowed to participate.
What is different this time? Again, the difference may lie in Rajan’s approach. The Rajan report says:
“The architecture of trading with SEBI-regulated exchanges is conducive to free entry for financial firms and free entry for participants. As an example, currency and interest rate derivatives could become immediately accessible to all financial firms and all market participants (for example, FIIs) by bringing them into the existing policy framework of SEBI-regulated exchanges.”
Third, in the past, the market design of the product has prevented ‘cash settlement’ of interest rate derivatives.
In contrast, the Rajan report says:
“Exchange-traded interest rate derivatives using both cash settlement and physical settlement should be permitted. These can trade alongside equity derivatives on NSE and BSE.”
Fourth, in the past, it was claimed that the existence of interest rate derivatives interfered with the conduct of monetary