The Reserve Bank of India (RBI) has seen taking positions in the non-deliverable forward (NDF) market of the currency to manage fluctuations in the local currency. Indian Rupee has been under stress since start of this calendar year due to persistent outflows of funds by foreign investors from Indian equities and imposition of tariffs by the US.
Usually, the central bank remain proactive in the local over-the-counter (OTC) spot market to manage the undue volatility in the local currency, but recently, the selling in the NDF market is also been seen to curb volatility.
To understand this better, here is an explainer.
What is NDF and how is it used in currency management?
NDFs, as they are referred to in the market, are financial contracts that enable investors to hedge or speculate on the future value of a currency. They are commonly traded in offshore currency markets and are frequently used by investors who do not have direct access to the relevant currency’s onshore market.
NDFs are commonly used by investors to mitigate currency risk in emerging market economies, where the currency concerned is volatile.
When does the RBI use this tool?
Usually, the central bank intervenes in the spot OTC market to curb the rupee's volatility but more recently, it has changed tactics and started being active in the NDF market.
Taking positions in the NDF market has a benefit of not spending foreign exchange from the reserves. On the contrary, in the spot market, the central bank has to spend dollars to reduce the volatility leading to reduction in forex reserves.
How often has it been used in the past and has it proved to be an effective tool?
The RBI has been using NDF market interventions for the past few months as part of its strategy to reduce the volatility in the rupee's value.
According to RBI bulletin data, outstanding net forward sales by the central bank stood at $53.355 billion in August, $57.850 billion in July, $60.390 billion in June, $62.215 billion in May, $72.575 billion in April, $84.345 billion in March and $88.753 billion in February.
Why is the RBI relying more on this now?
Experts said that the rise in volatility in the local currency after the imposition of tariffs by the US and outflows of funds by the foreign portfolio investors, resulted in RBI intervening in the spot and NDF market.
The NDF market has become the RBI's preferred market to keep the currency's volatility at the desired level, currency experts said.
What are the disadvantages of taking positions in NDF market?
Intervening in the offshore NDF market allows the central bank to influence rupee movements beyond domestic borders and curb excessive speculation. However, such interventions come with notable drawbacks. The NDF market is largely offshore and unregulated, which limits transparency and makes it harder to assess the extent and impact of RBI’s actions. It can also send confusing policy signals if not aligned with onshore operations, leading market participants to misread RBI’s stance as defending a specific exchange rate level rather than containing volatility.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
