Rupee at 80 for a dollar: This derivative sets a one-year time frame

The rupee has depreciated 5 percent so far in 2022 and there are no prizes to predict that the losing streak will last longer. The rupee’s weakening trend is a direct fallout of dollar outflows triggered by a fast-tightening US Federal Reserve.

At such a time, it is pertinent to track the offshore non-deliverable forward rate for the dollar/rupee pair. NDF is a forward contract where the trader has the choice but not the obligation to deliver the underlying currency. In other words, NDF is a pure punt derivative instrument and predicts how an exchange rate may fare in the future.

If offshore NDF rates for the dollar/rupee pair are to be believed, the Indian currency is expected to weaken closer to 79 to its US counterpart in three months. What’s more is that the rupee could touch a low of 80 per dollar in a year’s time.

To be sure, NDF rates tend to over-influence and overpower the domestic spot exchange rate during times of depreciation. Indeed, the difference between the onshore spot exchange rate and that of the three-month offshore NDF rate widens during depreciation episodes. This gap has widened to roughly 80 paise now from about 70 paise on average last month.

When the gap widens, it opens up an arbitrage opportunity for traders which, in turn, exacerbates the weakness of the exchange rate here. The offshore NDF rate has consistently shown a weakening outlook for the rupee since the pandemic hit in 2020. With global central banks poised to tighten policy faster, the dollar’s value has only increased.