To stop the Indian Rupee’s (INR) slide or decline, India’s central bank, the Reserve Bank of India (RBI), has asked local banking institutions to stop increasing their positions in the Non-deliverable Forward (NDF) market. According to traders and bankers, this step may cause offshore instability to spill over to local markets.
The RBI is being forced to use additional reserves to protect the Indian Rupee (INR) due to the increasing positions in the market segment. In contrast to the directives it gave in June 2020, which permitted banking institutions working from the banking unit of the International Financial Services Center (IFSC) to trade in the Non-deliverable Forward (NDF) segment, the central bank’s informal communication to local banking institutions is a step in the wrong direction.
After research revealed that the Non-deliverable Forward (NDF) market, which was dominated by foreign banking institutions and on top of which the central bank had just a little control, fueled volatility as well as frequently drove the spot Indian Rupee (INR) lower in stressful situations, the RBI took action in the year 2020. If banks in India were permitted to trade in the market, the central bank would have better oversight. The spot INR is so far under pressure, but rising trading in the category has raised the demand for US Dollars (USD), requiring the central bank to step in through USD sales.
Anindya Banerjee, who is the Head of Research in foreign exchange (forex) and interest rates at Kotak Securities Ltd, stated that according to the Reserve Bank of India’s assessment, the Non-deliverable Forward (NDF) was invalidating the influence of their interference as well as enlarging forward market liquidity, neither of which it desired.
In the meantime, the sharp depreciation of the INR in the past few days has created chances for arbitrage among offshore and onshore rates. The arbitrage grows the demand for USD domestically, at the same time increasing liquidity internationally.
Banking institutions contend that the central bank’s restrictions on the banks’ Non-deliverable Forward (NDF) operations won’t relieve pressure on the INR. Rather, it may result in offshore rates having a greater impact on the INR exchange rate. The issue is that the distinction between onshore and Non-deliverable Forward (NDF) will endure now that banking institutions have been ordered to back off.