Money & Banking

USD/INR trade: RBI may look at intervening in NDF market, says SBI report

BL Mumbai Bureau | Updated on: Mar 14, 2022

The report notes that this will not impact rupee liquidity, and direct intervention in NDF market will reverse USD arbitrage

The US Dollar (USD)/Indian Rupee (INR) is expected to trade in an elevated zone but ideally, the FY23 average should not be higher than 76-78 per USD, with an appreciating bias, according to a report by State Bank of India’s economic research department (ERD).

The aforementioned projection assumes that the Russian-Ukraine conflict would drag on for now.

Referring to alternate settlement mechanisms being envisaged by select nations desirous of continuing inter-territorial trades of compulsory nature, circuiting around the western sanctions, Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI, said, “...this should present the moment of reckoning for the internationalisation of rupee too, underpinning the need to evolve alternate payment and settlement mechanisms. Let us grab the iron when it is hot!”

SBI’s Ecowrap report noted that during the global financial crisis, the rupee had continued to decline and lost around 13 per cent during January 2008 to July 2011.

However, in the post crisis period, the volatility had become significant (4.6 per cent) and INR declined by 41 per cent during July 2011 to November 2013.

But the recent episodes of rupee volatility has been much less and lower forex volatility in India (USD/INR volatility movement in the range of 1-2 per cent) have diminished the depreciation risks, and hence ERD expects rupee not to be majorly impacted.

“However as a matter of fact, one should not rule out episodic currents of volatility in local currency against the USD in case of further negative geopolitical surprises,” cautioned Ghosh.

NDF intervention

The report observed that RBI may look at intervening in the Non-Deliverable Forward (NDF) market instead of the onshore market through banks during Indian time zone.

“This has the benefit of not impacting rupee liquidity. Also, majority of the USD buying in onshore market follows offshore market, either for view-based trades or arbitrage. Directly intervening in the NDF market will reverse the arbitrage,” Ghosh said.

The ERD underscored that with the onset of global turbulence, the offshore market players have now also turned buyers of USD and this would have further pushed the rupee lower.

“In this context, one known unknown that might be made clearly known known is publishing the data on offshore market rupee dollar transactions by RBI (currently not published) that would impart a lot of transparency and credibility in the market! By publishing the data, even with a lag, the RBI could actually move the market with it!” the report suggested

What is NDF market?

NDF markets have generally evolved for currencies with foreign exchange convertibility restrictions, particularly in the emerging Asian economies, RBI officials Sangita Misra and Harendra Behera said in a 2006 Occasional Paper.

“With controls imposed by local financial regulators and consequently the non-existence of a natural forward market for non-domestic players, private companies and investors investing in these economies look for alternative avenues to hedge their exposure to such currencies.

“In this context, non deliverable forwards have become popular derivative instruments catering to the offshore investors’ demand for hedging. NDFs are types of derivatives for trading in non-convertible or restricted currencies without delivery of the underlying currency,” the officials said.

Trading in the NDF market generally takes place in offshore centres. In this market, no exchange takes place of the two currencies’ principal sums; the only cash flow is the movement of the difference between the NDF rate and the prevailing spot market rate and this amount is settled on the settlement date in a convertible currency, generally in US dollars, in an offshore financial centre, the Paper said.

The other currency, usually an emerging market currency with capital controls, is non-deliverable.

Published on March 14, 2022
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