A derivative is a contract whose price is derived from an underlying item to guard economic agents against uncertainties of fluctuations in the price of the asset. Foreign exchange derivative can be used as an instrument to hedge the risk arising out of exchange rate fluctuations. The study aims to look after the current use of derivative products, review the legal and regulatory framework and analyze the prospects of the foreign exchange derivative market in Nepal using literature review, questionnaire survey and focus group discussion among stakeholders.
The study reviews foreign exchange (FX) derivatives markets of the SAARC region and draws important insights for Nepal. The study finds that FX derivative market is operational in the emerging economies of Bangladesh, India, Pakistan, and Sri Lanka. However, other South Asian economies are yet to develop the FX derivative market. It turns out the more FX exposure and developed financial market, the better is the scope for FX derivative market.
The survey finds that the use of derivative products from commercial banks has increased by about 60 percent with a trading volume of Rs. 143.12 billion in the week ending mid-July 2018 to Rs. 228.94 billion in the same period of 2020. The study also finds that the derivative instruments used in Nepal are limited to forward and swaps, with non-deliverable forwards dominating the volume of trade. Though the market is increasing, it is uni-dimensional on the sell side.
A survey result of this study finds that all commercial banks operate in the forwards market while half of them deal in swaps. Among national-level development banks, none of them use derivative instruments. Among 81 responding non-financial firms out of 115 samples, only 12, mostly steel and metal manufacturing firms, hedge their foreign exchange exposure using forwards. Most firms (30) do not have FX risk and 27 firms who are exposed to FX risks do not use them due to lack of knowledge about the market.
Given liquidity, market participation, legal provisions, understanding of the matter, and market infrastructure, the FX derivative market is still developing phase in Nepal. Separate legislation on FX derivative trading is required. It is important to strengthen the current OTC market. Long-term forwards, swaps and options can be promoted in Nepal for hedging at present. These will not only facilitate hedging but also will attract the prospective Foreign Direct Investment (FDI). Once the OTC market is developed enough, prospects of the exchange market could be explored further
Source: NRB Click Here to View Original Document of the Study
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