Interest Rate Derivatives in India: Challenges and Opportunities

Risk taking has become the order of the globalised and integrated financial markets. And, Indian financial market is no exception. In recent years, due to high employment, inflation, and increased demand for durable consumer as well as producer goods, the interest rate in India has become more volatile thereby making the debt market relatively risky and uncertain. The risk arising from the unfavourable changes in interest rate has repercussions on financial, corporate and household sectors. This interest rate risk has the evidence of adversely influencing the market value of banks’ assets as well as the earnings from assets, fees and the cost of borrowed funds. Necessity is the mother of invention. And, it has came into being with flying colors when the effective risk management process in India has made a path breaking contribution by introducing interest rate derivatives – 10 Year Notional Coupon-bearing G-Sec in 2009, and 91-Day T-bill in 2011 so as to hedge interest rate risk. But the challenge is to maintain the glamour. It is due to certain structural factors like lack of liquidity in the underlying cash market, prescription of Statutory Liquidity Ratio, and the facility of Held to Maturity, the activities in the interest rate derivatives market have not yet been very attractive in India. Lack of significant buy-side interest and market hesitancy to take a view on long-term interest rates are among other factors hindering lucrative market activities. The opportunities lie in widening the investor base, and encourage participation of investors with diverse views on future outcomes.