For years, movements in the domestic currency market closely tracked price action in the offshore NDF market-an area over which the Reserve Bank of India (RBI) has little direct control. This influence became so pronounced that the central bank, despite not formally acknowledging the NDF market for decades, eventually began taking positions there to influence movements in the onshore currency market.
As the name suggests, the NDF market operates offshore and outside the RBI’s regulatory jurisdiction. Traded mainly in financial centres such as Singapore and London, rupee NDF contracts are settled in dollars between non-resident counterparties, limiting the central bank’s ability to directly influence volumes, pricing or positioning. “The impact of the NDF market has significantly diminished but has not completely disappeared,” said Anindya Banerjee, head of commodity and currency research, Kotak Securities, referring to the latest central bank curbs aimed at bolstering the local unit. “NDF signals can still influence onshore spot volatility, especially when offshore volatility rises. However, the extent of such spillover has been curbed as direct arbitrage flows between offshore and onshore markets have been significantly reduced by regulatory curbs.”
Because the NDF market is open around the clock, the USD/INR rate often reacts immediately to major global developments, with these moves subsequently feeding into onshore trading when domestic markets open.
Since the beginning of March, the rupee has fallen about 4.5% against the dollar, sliding from 90.98/$ to a low of 94.81/$ on March 27. During this period, the RBI is estimated to have sold nearly $15-20 billion to prevent a sharper decline in the local currency, though these interventions did little to arrest the weakness.
Regulatory Restrictions
Late on March 27, the RBI issued a directive asking banks to cap their net open foreign-exchange positions at $100 million with effect from April 10, a move aimed at curbing the rupee’s fall. However, on the very next trading day, the currency touched a fresh low of 95.22/$ on March 31.
The following day, as pressure on the rupee intensified, the RBI stepped up its measures, prohibiting banks from offering rupee NDF contracts to their clients. Banks were also barred from rebooking any cancelled foreign-exchange derivative contracts, whether deliverable or non-deliverable. These measures took effect immediately.
The restrictions forced banks to begin unwinding their existing NDF positions and refrain from taking new ones. Until then, banks had been exploiting arbitrage opportunities by buying forward dollars in India and selling dollars forward in the NDF market. After the April 1 announcement, the direction of these trades reversed, with banks buying NDF forwards and selling dollar forwards onshore, helping stabilise the INR/dollar spot rate in India. From April 2 onward, the rupee strengthened to close at 93.06/$, around 2.2% firmer than its March 31 close.
Even so, during periods of heightened volatility, the RBI’s ability to intervene in the NDF market may remain limited, particularly when domestic markets are shut, people familiar with the matter said.
The central bank has, however, built up a sizable net forward position in the NDF market to stabilise the rupee, with its forward book standing at around $77 billion as of end-February, the highest level in 11 months.
Traders cautioned that if offshore trading becomes increasingly detached from onshore positioning, large bets against the rupee in overseas markets could once again influence domestic levels. In such cases, the RBI may find it harder to maintain stability, especially during overnight moves.
Even as banks have stopped offsetting onshore positions through the NDF market, arbitrage opportunities have not been fully eliminated. Foreign institutional investors continue to hedge via NDFs due to restrictions in the onshore market, allowing the offshore segment-where contracts do not involve physical delivery-to continue influencing spot rupee movements, said K N Dey, a veteran foreign-exchange market consultant.
“The NDF market gained momentum after the RBI discontinued currency futures trading on Indian exchanges,” Dey said.
Market participants said that the arbitrage opportunity, which earlier stood at as much as 25 paise for a one-month tenor, has now narrowed to around 10 paise, though it has not vanished entirely.
Following the RBI’s latest restrictions, price discovery in the NDF market is likely to be driven more by global players’ positioning, traders said.
