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OP-ED: Hedging risk for bulk imports, policy support needed

  • Published at 09:58 pm August 3rd, 2021
Chittagong port import export trade
File photo of Chittagong PortDhaka Tribune

Given the reality, the central bank should allow purchase of exchange traded futures and options for containment of price volatility risk

Imposition to require approvals from competent authorities means that the very work is being discouraged to do so.

With regards to import of the country, transactions of which are guided by the trade regulations like import policy order in force.

The settlement of payments for the import is subject to the regulatory framework issued by the central bank under the foreign exchange regulations.

The Bangladeshi Taka is convertible on current account transactions under the prevailing foreign exchange regulatory regime.

No permission from the central bank is required to effect payment for transactions under the current account including import payments.

Central bank’s regulations also allow import payment in advance against repayment guarantees provided that such guarantees are acceptable to concerned authorized dealer (AD) banks designed for the transactions. 

The prevailing practice for import transactions is to import on bilateral arrangements between importers and suppliers.

Agents at both ends may work to materialize the deals. The payments mode may be on sight basis, or on usance terms in case of the transactions executed under supplier’s/buyer’s credit, depending on the nature of goods.

The underlying documents for imports may be either letters of credit or sales contracts based on the nature of transactions.

Limited scope is available for commercial imports under sales contracts as per import policy order in force.

The arrangement to import in this way is generally known as ‘over the counter’ transactions, price of which is set as per negotiation between parties.

In addition to bilateral negotiations, there are commodities exchange houses where commodities are traded. 

Standardized contracts like futures, options and such other product-jargons for contracts are transacted in commodities exchange houses.

Different texts define exchange traded futures as a standardized legal agreement to buy or sell commodities at a predetermined price at a specified time in the future.

The deals settled through exchange houses for which arm’s length deals are possible to be executed.

On the other hand, options means a contract which gives its buyer the right, but not the obligation, to buy or sell underlying commodities at a specified price prior to or on a specified date, depending on the form of the option.

Options 101

There are two basic types of options – call options (buy options) and put options (sales options.)

Options may, besides standardized contracts transacted at exchange houses, be traded between private parties as over the counter transactions. 

Operational modalities of commodities exchange houses are to a great extent the same as those of stock exchanges.

The contracts transacted at commodities exchange houses work as price volatility mitigation tools.

The deals through exchange houses may be either ‘deliverable’ or ‘non-deliverable’, meaning that commodities may either be delivered or counterparties settle the difference between the set price and the prevailing spot price.

Though settlement of import payment does not require permission from the central bank, booking of commodities with commodities exchange houses is subject to approval from the central bank.

Approval process seems to be as good as traditional bureaucratic formalities which are time consuming.

Central bank’s regulations tell that AD banks can hedge the price risk of commodities that are traded on exchanges or over the counter of their customers through standard exchange traded futures/options and over the counter derivatives on commodities subject to prior approval. 

The regulations state that the use of commodity derivatives will only be permitted when customers have genuine underlying commodity price risk exposure.

This can be monitored by AD banks through checking of the underlying risk exposure documents. Any kind of speculation through the use of commodity derivative instruments will not be permissible.

AD banks must completely hedge the commodity price risk arising from the commodity hedge transactions by booking back to back transactions with banks having international standing or their branches operating in Bangladesh, the regulations note.

Central bank wants applications through AD banks with information regarding suitability and appropriateness in a prescribed form.

In addition, the regulations impose on AD banks different instructions for compliance.

Insider information from different trade bodies indicate that central bank’s regulations are decade-old but few transactions have been executed as of now with its prior approval.

It is known that trade bodies especially those producing output for local consumption, and intermediate goods for local delivery to exporters would approach central banks for allowing general permission but no outcome was found.

The approval process is time consuming which leads to failure of onward deals for booking, even if approved, with exchange houses at expected prices.

As a result, importers rarely approach the central bank, rather they manage the price risk through low cost external import finance, enhancement of output price, and subsidies from the government.

In some cases, booking with exchange houses, as per insider information, is made otherwise through the help of third parties working in different trade hubs like Singapore, Hong Kong, Dubai, Switzerland and other places.

It is true that deals without permission may lead to speculative bookings and counter or re-sales of ‘futures’.

It is not easy by regulators to monitor the transactions executed abroad.

On the other hand, the approval route is not workable for importers considering market movements at every minute.

In this paradoxical situation, the central bank should come up with policy support as a pilot program.

What can be done

Given the reality, the central bank should allow purchase of exchange traded futures and options for containment of price volatility risk, with facilities to offset the position.

‘Over the counter’ contracts may also be allowed with an option to square the position by an opposite transaction with the same broker in case of cancellation.

Central bank should, in its regulatory guidance, articulate necessary caveats to avoid arbitrage and/or speculative transactions.

The regulations will also include import transactions to be carried out under the contracts on maturity in compliance with appropriate regulatory instructions.

The proposition as noted above should be allowed only for companies engaged in production of final output for local consumption or direct export, and companies producing intermediate outputs for local delivery to manufacturers of the final export for permissible import of input contents in the international commodity exchanges/markets.

In this case, AD banks need to be allowed to effect remittance towards margin/premium payments from time to time, including maintenance of accounts with authorized commodities traders abroad.

In lieu of making a direct remittance, AD banks should also be given permission to issue guarantees/standby letters of credit for specific payment obligations.

Purchase of exchange traded standard futures and options with facilities to offset the position may keep importers safe from volatility of commodity prices in the international market.

On the other hand, prices in exchange traded commodities reflect fair prices with no option for misinvoicing.

The downside risk of the deals is that importers may incur premium or booking costs, if the position is not possible to be offset by an opposite transaction, which are sustainable compared to financial risk associated with movement of prices.

Since no commodities exchange houses are in operation in our country, importers need to depend on commodities exchange houses abroad.

Deals with exchange houses abroad require trading accounts with authorized commodities dealers.

Maintenance of such accounts abroad is not so easy, it needs to observe different regulatory compliances.

As such, resident merchant banks/stock brokerage houses should be allowed to trade with commodities exchange houses abroad on behalf of importers in Bangladesh.

During the ongoing situation due to covid-19, the volatility of commodities prices is unknown for the coming days.

To keep the domestic commodities market stable, the central bank should think of what should be done to facilitate price stability in the domestic market.

The proposed policy support will refrain central banks from operating low cost refinancing support programs.

 

The author works in the development sector and can be reached at [email protected]

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