The Reserve Bank of India (RBI) has of late been taking positions in the non-deliverable forward (NDF) market to manage currency fluctuations, reflecting pressure on the rupee.
Traditionally, the RBI has been more active in the local over-the-counter (OTC) spot market to keep the rupee stable. But recently, the central bank has been selling in the NDF market to contain exchange rate volatility.
Earlier this year, RBI governor Shaktikanta Das said the central bank was present in the NDF market and that the intervention had undergone some changes.
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 measure?
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.
Stepping into the NDF market has the added benefit of not depleting the RBI's foreign exchange reserves. This is in the spot OTC market, it has to trade at the current value of dollars or other components of the forex reserve basket, whereas in the NDF market, counterparties have to merely settle the difference between contracted rate and prevailing spot prices.
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 seven months as part of its campaign to limit volatility in the rupee's value.
According to RBI bulletin data, outstanding net forward sales by the central bank stood at $14.580 billion in September, $18.98 billion in August, $9.10 billion in July, $15.83 billion in June, $10.36 billion in May, $16.257 billion in April and $541 million in March.
However, even as there was heavy selling in the NDF market, India’s foreign exchange reserves surged by $79.25 billion.
During March to September, the rupee depreciated 1.07 percent.
Why is the RBI resorting to it now?
Blame it on the rise in volatility in the wake of the US presidential election and India's slower-than-expected economic growth, which has prompted foreign investors to pour out of the domestic equity market.
The NDF market has become the RBI's preferred market to keep the currency's volatility at the desired level, currency experts said.
Has the objective been achieved?
According to market observers, the RBI has been able to limit the volatility in the rupee to some extent by stepping into the NDF market, and without the country's forex reserves taking a hit, to boot.
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