With more underlying added in future, the IRFs contract may get good trading volume. While there is a fear that like other derivative contracts, this product may also get influenced by actions of punters, multiple players and large institutions are expected to reign in that activity to a great extent
Interest rate futures (IRFs) are back in its new avatar, after having failed couple of times in the past. After Reserve Bank of India (RBI) deciding to introduce interest rate futures in the second quarter monetary policy review, and subsequently issuing a notification in this regard on 5 December 2013, all three bourses—National Stock Exchange (NSE), MCX Stock Exchange (MCX-SX) and BSE—decided to launch interest rate futures. The MCX-SX became the first stock exchange to launch this on 20 January 2014. NSE and BSE are going to shortly launch this.
Need for interest rate futures
Interest rate futures are a very actively traded derivatives contract worldwide. In fact the trading value (notional) in the interest rate futures contracts in US is as high as 80% of the total number of contracts traded. In India, till now it has been zero with earlier versions of interest rate futures having failed completely. The date below shows that trading volume in interest rate futures contracts:
The need for interest rate futures contract arises from two prime reasons: hedging and trading. Like other derivative products, interest rate futures are also a highly speculative product with most participants speculating on the interest rate movements to make money. While hedging with interest rate is also a good strategy to mitigate risk, this is used by banks and financial institutions. Since RBI has allowed banks in India to trade in these contracts, it needs to be seen what kind of depth the contract acquires in terms of trading volumes. The banks are not allowed to trade in these contracts on behalf of clients.
What has changed in the re-launched IRFs contract?
Interest rate futures contract was earlier based on a notional 10-year bond with a fixed 7% coupon rate. Investors then had no way of hedging against holdings of real 10-year bonds floated on different dates with varying coupons. Adding to the woes was physical settlement of contracts. Trading of contracts on notional bonds and delivering actual bond against these notional bonds, did not find favour with the buyers as sellers had the option to deliver what was called as ‘cheapest to deliver’ (CTD) bonds.
Now, real bonds have replaced notional bonds. The bonds allowed in interest rate futures is 8.83% Government of India (GoI) bond maturing on 25 November 2023 and 7.16% GoI bond maturing on 20 May 2023. These bonds are liquid bonds in the delivery-based market and attract lots of volume. Also, cash settlement means that there won’t be supply side pressures on these bonds. The new interest rate futures contract may help boost the volume in Negotiated Dealing System-Order Matching system (NDS-OM) where the underlying is also traded. The price differences between futures and spot, like any other market, creates arbitrage opportunities. Banks and the financial institutions will be beneficiaries of this as they have large exposure to government bonds.
Does it offer anything for retail investors?
It will be better if retail investors stay away from these contracts. However, investors knowledgeable of interest rate futures can use these contracts to hedge exposures on loans. This essentially means reducing risks arising from rising interest rates. As the exposure into home loans is generally of the large size the investors can think of mitigating risk using these contracts. As per contract specifications of MCX-SX, the initial margin and extreme loss margins are not very high and this would mean not a very investment by retail investors.
By design, the interest rate futures look more logical and should be acceptable to the market players. With more underlying added in future, the contract may get good trading volume. While there is a fear that like other derivative contracts, this product may also get influenced by actions of punters, multiple players and large institutions are expected to reign in that activity to a great extent.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
Indian government needs to review factors affecting LNG opportunities very seriously and ensure when adequate gas production is reached at domestic level, first priority should be for both agriculture and power generation so that a lot of subsidy burden can be reduced
In order to produce NKP (nitrogen, phosphorous and potassium) class of fertilisers, Fertilisers and Chemicals Travancore Ltd (FACT) requires Ammonia, for which it uses natural gas, obtained for Petronet LNG. Petronet LNG has a terminal at Cochin. Recently, the LNG price has been raised to $24.35 per unit (million cubic metres) from the existing rate of $21.5, causing avoidable hardship and increased costs to the fertiliser company. On the top of this, recently, FACT has been persuaded to buy an entire shipment of 80 million cubic metres, whereas the requirement is only 20 mcm for a month, with which they would be able to produce fertilisers, including roughly 80,000 tonnes of caprolactum and factamphos needed by agriculturists.
Normally, FACT shuts down the plant during April-May for annual maintenance, and their officials now feel that such a large supply would be a burden. Besides, every increase in LNG price, in dollar terms, sets back the company by about Rs50 crore per year.
RK Garg, director of finance, Petronet LNG, has clarified that sale of natural gas to consumers was being done by a consortium of GAIL, BPCL and IOC, and that gas is sold at spot rates. Naturally, if the rates prevailing in the global markets rose higher due to demand in winter, this will automatically affect the price in India. He has also stated that they normally give two months advance notice in regard to price increase.
In any case, in order to assist the regular and large consumers, like FACT, if Petronet LNG are notified their annual firm needs (commitments, really!) and then would be able to supply at better prices! This would be applicable to all fertiliser units, and they need not resort to import of ammonia itself directly, which is what FACT is planning to do! What is the problem for FACT to make this information available?
One more issue that has affected large consumers such as FACT, refers to the State government-levied VAT (value added tax of 14.42%) on LNG, and they have requested that this should be waived, for at least five years, for the industry to establish itself. In any case, any tax would ultimately find its way to be charged to the consumer and for the government to give subsidy on fertiliser has a cyclic effect!
It may be noted that in 2009, Petronet LNG signed a 20 year contract with Mobil Australia Resource Co Pty Ltd, for supplying 1.4 million tonnes annually for the Kochi LNG terminal. According to AK Balyan, managing director and chief executive of Petronet LNG, imported gas from the spot market comes at about $18 per unit (mmBtu) while on long term contract price comes to about $13 per unit, as against the domestic gas price, which ranges, from $4.2 to $5.7 per unit, at the moment. This will practically double with effect from 1st April this year! Even then, Indian gas would be cheaper, but the pity is that it is not available in the required quantity, at least for the time being!
Even the above contract is linked to crude oil prices internationally and if crude prices soften, gas price will automatically come down, as per Balyan.
In the recently held Petrotech 2014 conference, Veerappa Moily, our petroleum minister, had the opportunity to meet many interested delegates, one of whom, Nizar al-Adsani, head of the Kuwait Petroleum Corporation (KPC) had shown interest in the industry. Moily urged Kuwaiti participation in the LNG Terminals at Visakhapatnam (Andhra Pradesh) and the Mangalore/Pudur units in Karnataka since India plans to set up 12 such terminals all over the country.
In fact, earlier, ONGC and KPC had signed a memorandum of understanding as KPC wanted to invest 26% of Rs21,396 crore petrochemical plant in Dahej, Gujarat, as well as another in Mangalore. Further details are expected shortly.
In the field of LNG development, another important development relates to the global tender floated by GAIL for LNG ships to haul 5.8 million tonnes of LNG, purchased from USA, for delivery spread over 20 years, from 2017 onwards. These 12 ships are estimated to cost about $2.8 billion, in addition to which GAIL may also lease seven to eight vessels to bring in the LNG to India. LNG ships cost about $200 million each, depending upon design, type, capacity and volume, and the oil ministry wants domestic shipbuilders to explore the possibility of supplying some! China, with whom India is always compared, almost in every field, has built a number of such vessels, which are owned by local fleet owners!
It may be of interest for the reader to note that Cochin Shipyard built India's aircraft carrier, and there is no reason why they should not be given the opportunity to build LNG tankers. Apart from Cochin Shipyards, only Larsen & Toubro, who have technical collaboration with Mitsubishi Heavy Industries of Japan may be given special consideration to promote the Indian shipbuilding industry, as Mitsubishi have the required expertise.
However, the Indian shipping industry, according to KM Sheth, executive chairman of Great Eastern Shipping Company, are burdened with a "service tax of 12%" and tax on seafarer's income, resulting in loss of experienced personnel from the industry. In fact, only tax incentives have helped the development of this industry in countries like Singapore, Norway and Greece, to name a few. At one time, Indian vessels carried 35% of the national cargo, but today, it is less than 10% as we appear to depend upon foreign carriers, and our growth is only 1.5% of the world's tonnage!
Indian government needs to review these factors very seriously and ensure when adequate gas production is reached in the domestic sector, the first priority should be for both agriculture and power generation so that a lot of subsidy burden can be reduced, if not totally avoided! But for the present, instead of indirectly forcing FACT to import Ammonia, the government must seriously consider waiving the service tax of 14.42% for a start!
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)
Why are there so many bank branches in a tiny town
Here is a quiz question. Which town in India has the maximum number of bank branches and is the favourite destination for public sector banks to launch new products and services? In case you are clueless, the answer is Sivaganga, a little-known district in Tamil Nadu, which happens to be the constituency of P Chidambaram, India’s finance minister, at various times over the past 15 years.
While Amethi and Rae Bareilly, the constituencies of Rahul and Sonia Gandhi, respectively, may be lagging in development and infrastructure, Mr Chidambaram has ensured that his constituency is not lacking in banking services and easy loans. The district has a whopping 200 branches and every bank chairman knows that the best way to attract the FM’s benevolent attention is to open a branch, or launch a mobile banking service at Sivaganga, and to invite Mr Chidambaram to inaugurate it. According to a newspaper report, the finance minister has visited his constituency 95 times in the past four years and is always happy to do a bit of ribbon-cutting during those trips.
Unfortunately, senior bankers also admit that no chairman cares about the branch beyond the grand inauguration and initial lending to impress the minister. Immediately afterwards, the branch begins to languish.