Offshore challenge

The higher transaction volume in the offshore non-deliverable forward (NDF) market compared to the onshore market for the rupee, is proving to be a deterrent to effective foreign exchange management by the Reserve Bank of India (RBI). The growing influence of the offshore market on domestic forex movement was further established by a recent RBI working paper written by Harendra Behera, Rajiv Ranjan and Sajjid Chinoy. The paper notes that in normal circumstances, both the onshore and offshore markets for the rupee tend to influence each other. But in periods of heightened uncertainty such as during April 2012 to November 2014 and October 2017 to December 2019, the price volatility in the offshore NDF market tends to spill over to the domestic market. This influence impedes forex management since the participants of the NDF market are based in offshore centres in London, Singapore and New York, beyond the purview of the RBI. It is not possible to control these markets that have sprung up due to the capital control and restrictions on foreign participations in the domestic forex market. Hedgers and speculators have been increasing their activity in emerging market currencies such as the rupee, Brazilian Real, Taiwanese New Dollar and South Korean Won in the NDF market in recent past. According to the BIS Triennial Survey, 2019, the rupee enjoyed 19.4 per cent share in NDF market in 2019 and turnover in offshore rupee contracts had increased 200 per cent between 2016 and 2019.

The RBI has been closely monitoring this market since the 2013 forex market crisis when the depreciation in rupee was exacerbated by speculators in the NDF market. In 2019, the Task Force on Offshore Rupee Markets, under Usha Thorat, had given many suggestions to curb its influence. Some of the suggestions such as allowing trading of rupee derivative contracts in the international financial service centre in the GIFT (Gujarat International Finance Tech) City and allowing Indian banks in the GIFT City to participate in the offshore NDF market have been implemented over the last two years. These measures are likely to curb the influence of the NDF market. However the RBI should be careful to not intervene too much in the forex trades on the GIFT City, in order to create a conducive environment for attracting foreign investors from other offshore centres. The increase in trading hours in rupee derivatives in the GIFT City is also likely to bring offshore trading volume to India.

However, it is too early to expect a dramatic migration of trades from other offshore centres. The RBI will have to keep a tight watch on this market, especially with the possibility of another “taper tantrum” as central banks begin monetary tightening. It should also consider simplifying the registration process for non-residents to enable easier access to foreign participants in the onshore rupee market. A centralised KYC registration across financial markets as recommended by the Task Force, can be considered.

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