October 31: The foreign exchange derivative market in Nepal is still in the developing stage, according to a study conducted by the Nepal Rastra Bank. The report reviewed the current practices of the foreign exchange-based derivative market in Nepal on the issues like liquidity, market participation, legal provisions and sectoral knowledge. 

The study points out the need for a separate law to govern foreign exchange derivative market. The survey was conducted amongst commercial banks, development banks, and non-financial firms. It has found that the derivative instruments used in Nepal are limited to forward and swaps, with non-deliverable forwards dominating the volume of trade.

All commercial banks in Nepal are involved in the forwards market while half of the banks are involved in swaps. According to the study, none of the national level development banks use any derivative instruments. Development banks manage foreign exchange risk through asset liability matching. 

Commercial banks have conducted such transactions of Rs 228.94 billion in 2020. The report states that such transactions increased relatively in 2020. In 2018 and 2019, such transactions amounted to Rs 228.71 and 143.12 billion respectively.

Similarly, only 12% of non-financial firms have used derivative products and 37 % of firms have stated that there is no foreign exchange risk in their daily transactions which has discouraged the use of derivative products.  

The report states foreign exchange derivatives markets of India, Bangladesh, Pakistan and Sri Lanka are more organized than other countries in South Asia. According to the report, standardization of derivative instruments in the OTC market along with adding market participants will further support the development of the market. The report states that in order to facilitate the current over-the-counter (OTC) market and attract foreign direct investment, forwards, swaps and alternatives need to be promoted in the long run.

The report has highlighted the need of an organized exchange market with sufficient legal provisions. The participants of the survey have suggested to open up the two-way quotes, easy access to the derivative products based on the prospective exposure, opening investment opportunity to the Foreign Institutional Investors and addressing peg risk concerns with Nepali currency.