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The non-deliverable forwards (NDF) markets are exerting more pressure on onshore currency market, especially when rupee is under stress, the Reserve Bank said in its annual report quoting an internal research.
"During the period of (rupee) depreciation, shocks originating in NDF market may carry more information, which get reflected in the on-shore segments of the market through mean and volatility spillovers," says the study.
The rupee has plunged nearly 21% so far this fiscal and it touched a new low of 65.56 to the dollar in early trade today.
The NDF is a foreign exchange derivative instrument traded over-the-counter and is operated in currencies that are not freely convertible like rupee.
The market enables hedging of exchange rate risks, irrespective of any restrictions arising in the currency of origin.
The analysis says there is a long-term relationship between the spot and the NDF markets for the rupee.
"During the period of the (rupee) appreciation, the NDF market and the rupee spot market exhibit a bi-directional relationship," says the study.
However, at times of rupee fall, relationship turns unidirectional from the NDF to onshore market, the study notes.
The NDF, or the offshore, market remains outside the regulatory purview of the Reserve Bank. Domestic financial institutions are not allowed to transact in the NDF markets.
However, since the domestic banking entities are allowed specific open position and gap limits for their foreign exchange exposures, there is scope for these entities to participate in the NDF markets to take advantage of any arbitrage.
Foreign banks and corporate entities with an international presence can participate in the NDF market.
