The non-deliverable forwards (NDF) market for dollar/rupee has a greater influence on the domestic currency derivatives market in periods of depreciation, an emphirical study of the RBI shows.
Using statistical models, the study concluded that there is a long-term relationship between the domestic spot and the NDF markets for the rupee. “It would seem that during depreciation, shocks originating in the NDF market may carry more information, which gets reflected in onshore segments of the market through mean and volatility spillovers,” the RBI said in its Annual Report on Thursday.
The RBI study observed daily closing of NDF rates and onshore rates between June 6, 2006, to April 3, 2013, to arrive at the conclusion.
Going by the RBI analysis, rupee could remain under pressure in the coming days as the three-month non-deliverable forwards dollar/rupee rate is currently quoting at 66.74/$, higher than 66/$ on Wednesday. Three-month onshore dollar/rupee forward rate was 66.34/$ compared with 65.95/$ on Wednesday.
A thriving offshore NDF market has always complicated the RBI’s task of currency management. The NDF market for dollar/rupee came into existence to cater to foreign investors who are not allowed to hedge in the onshore forwards market but have an exposure to Indian bonds and equities. While the actual size of the NDF market remains unknown, a report from the Bank of International Settlement pegged the daily turnover of dollar/rupee NDF market at around $40 billion as of 2011.
A part of the Indian rupee’s massive fall during the May-July period was attributed to speculative transactions involving the arbitrage between the offshore NDF trades and onshore markets. In the past, RBI has avoided acknowledging the influence of the NDF market on the domestic market and has played down the impact.
However, given the magnitude of the rupee’s fall and NDF trades adding to the pressure, the RBI has become more vocal about its concerns over the market.
Recently, governor Subbarao said that the RBI is monitoring the NDF market closely and his deputy pointed out that NDF market is largely speculative.