Explained: Why offshore rupee market is gaining importance for RBI

The Reserve Bank of India (RBI) is having second thoughts on its currency intervention strategy and may include offshore non-deliverable forwards (NDF) markets in its field of operations.

This is to torpedo the activities of speculators dragging the rupee to record lows. 

The central bank, in its sixth bi-monthly monetary policy review, said it would form a task force to examine the offshore rupee market. 

The RBI’s Statement on Developmental and Regulatory Policies, released alongside the monetary policy statement, said, “The task force will examine the issues relating to the offshore rupee markets in depth and recommend appropriate policy measures that also factor in the requirement of ensuring the stability of the external value of the rupee,” the statement said. 

The terms of reference for the task force will be given by the end of this month, and they may not include any mention of offshore intervention. But sources say the central bank is thinking of bracing itself to cushion the onslaught of foreign speculators, against whom the RBI is helpless to act. The only way out is to take contra positions against speculators and let them cut their losses. 

The RBI, in the same policy statement, said the task force would explore how to “improve residents’ access to derivatives markets to hedge their currency risks”. And that continues to be the RBI’s official stance, basically to help offshore hedgers hedge their currency risks in India. 

However, the task force will be free to recommend other interesting ideas though all of it may not be made public. 

“The task force is for making policy recommendations; it may come out with a workable proposition for the RBI to operate through NDFs also in a legal, if at all a circuitous, way,” said a person familiar with the matter, but he maintained it remained to be seen if the terms of reference to the task force included such a move. 

NDF dynamics

The NDF market operates in major financial centres such as Dubai, London, and Singapore. The daily average trade in rupees in such markets is at least $60 billion. 

Even as the central bank can intervene in the domestic market and stabilise the exchange rate here, it has no control over the NDF market, which, most often than not, determines how the rupee will open the next day in the onshore market. 

NDF is used by foreign portfolio investors taking positions in India, which the central bank is trying to bring onshore. But a sizeable chunk of the NDF market is driven by speculators, which has always been a concern of the regulator.

“It will be a better world for us if there is no NDF market, but we cannot wish it away,” D Subbarao, then RBI governor, said in July 2013. 

The NDF market pulled down the rupee rapidly to record lows in 2013, and again in September-October last year, it wreaked havoc on exchange rates and on October 11, it reached its lifetime low closing of 74.39 a dollar. 

“Oil prices were responsible of course, but frankly, much of it was also speculation,” said Abhishek Goenka, managing director of IFA Global, a currency consultant.

In 2013, the RBI and the government were mobilising forces with other emerging markets for a joint operation in the offshore markets. The government reached out to other members of BRICS (Brazil, Russia, India, China, and South Africa) for such an action. 

Brazil’s then finance minister, Guido Mantega, had said the BRICS nations were contemplating coordinated actions to create a joint bank and joint reserve fund for offshore intervention. 

This was after emerging market currencies witnessed a rout on US taper tantrum concerns. Between May and August 2013, the Indian rupee fell 20 per cent to its then lifetime low of 68.87 a dollar in August. In calendar 2018, rupee fell 9.60 per cent. 

Brazil said no, as it moved to develop a domestic NDF market (DNDF). The RBI task force will explore developing such DNDFs for India as well, while keeping all options open, sources say. 

Merits and demerits

There is no hindrance for the RBI to enter the offshore NDF market anonymously, but it has to do so through an agent. This agent, however, will have to inform the local regulator about the client. 

While client confidentiality will be maintained from other market participants, the local regulator will have knowledge of RBI intervention.

Since it is a forwards market, the central bank will not have to shell out big money. The forwards interest for three months, being at 3 per cent, means the RBI can effectively sell just $300 million to support $10 billion worth of trades. 

But the central bank can easily scale up such interventions to a few billion dollars through forwards and that can easily deter any speculation. “If the market gets to know that the RBI is there to support the rupee in the offshore market, speculators won’t dare take long positions,” said Goenka. 

However, this could also be counterproductive at a time when the RBI is trying to develop the domestic forwards market.

“If RBI itself builds up volume in the offshore market, then why should a foreigner hedge onshore? He would rather access the NDF market to hedge,” said Samir Lodha, managing director of treasury management firm QuantArt Market Solution.