With FII's using the non-deliverable forwards (NDF) market to hedge against the rising rupee, the daily turnover in rupee NDF market has shot up from $100 million-$750 million.
Turnover has shot up as FIIs use the market to hedge against a rising rupee
MUMBAI: With foreign institutional investors using the non-deliverable forwards (NDF) market to hedge against the rising rupee, the daily turnover in rupee NDF market has shot up from $100 million in 2003-04 to $750 million so far in 2007-08.
A NDF is a cash-settled, short-term forward contract on a thinly traded or non-convertible foreign currency, where the profit or loss at the time at the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of settlement.
The absence of a forward market for offshore players in China and India has led to the development of the offshore foreign exchange market for investors to hedge their exposure. The major currencies traded are the Indian rupee, Chinese renminbi, the Indonesian rupiah and the Taiwan dollar.
The market for this offshore product for Asian currencies is concentrated in Singapore with some activity in London and New York.
“Volumes have shot up now as more FIIs, hedge funds and bigger multinational companies, which have a certain part of their risk in a particular country, are using this market to hedge their positions,” said a private bank dealer.
“Non-residents who want to speculate in the currency without taking exposure to the country and those looking for an arbitrage opportunity are actively involved in the rupee NDF market,” the dealer added.
However, the turnover for rupee NDFs is the lowest when compared with other currencies. “The lower turnover in the rupee NDF is due to exchange controls, the limited number of players and the absence of capital account convertibility. Also, there are restrictions imposed on hedging and speculations by the RBI,” said a foreign bank dealer.
The NDF market creates an arbitrage opportunity for traders which makes the RBI’s task of containing the rupee’s appreciation difficult.
“The quotes in the NDF market are sometimes based on opportunities (speculations) rather than fundamentals, which creates an arbitrage opportunity for traders,” explained a private bank dealer.
The rupee closed at a nine-year high of 39.59 against the US dollar on Wednesday.
The central bank in its annual report for 2006-07 said, “The NDF volumes are not that high to affect the domestic onshore market under regular market conditions, but may impact the domestic spot market in volatile market conditions.”
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