RBI concerned over rising NDF volumes

The Reserve Bank of India (RBI) is concerned about the possible impact of rising volumes in offshore rupee non-deliverable forwards (NDF) market on the rupee.

In its annual report for 2006-07, the central bank said, "While the NDF volumes are not large enough to affect the domestic onshore market under regular market conditions, these may impact the domestic spot market in volatile market conditions."

NDFs are derivatives used for trading in non-convertible or restricted currencies without delivery of the underlying currency. he NDF market in Indian rupee has been in existence for about 10 years, reflecting onshore exchange controls and regulations.

Non-residents wanting to speculate in the currency without any exposure to the country and those looking for an arbitrage opportunity, are active in the rupee NDF market, according to the central bank. The spread as well as volatility of the rupee NDF is higher than that of onshore spot and forward markets. From $100 million in 2003-04, the daily turnover in rupee NDFs has increased to nearly $750 million.

"The quotes in the NDF market are sometimes based on expectations rather than fundamentals. This creates an arbitrage opportunity for the traders, adding to the RBI woes in managing flows,'' said a treasury head of a private sector bank.

In recent years, the absence of a natural forward market for offshore players in economies such as China, India and South Korea, has led to the development of an offshore foreign exchange market for investors to hedge their exposure to these economies. The NDF market for Asian currencies is largely concentrated in Singapore, with some activity in London and New York.

The major trading currencies in the NDF market are the Chinese renminbi, the Korean won, the New Taiwan dollar, the Indian rupee, the Indonesian rupiah and the Philippine peso. The NDF rupee turnover is estimated to be lower compared with the Chinese renminbi, Korean won and New Taiwan dollar.

"The lower turnover in the rupee NDF can be attributed to the gradual relaxation of exchange controls and reasonable hedging facilities available to off-shore non-residents with exposures to the Indian rupee," said the RBI.