Rupee hit by an invisible force

MUMBAI: An invisible force is stalking the dollar/rupee market and the Reserve Bank of India could do little to stanch the local currency’s fast plunge.

Blame the “illegal” overseas non-deliverable forward (NDF) market.
Illegal, because such trades are not sanctioned by the Reserve Bank of India.

A NDF, as the name suggests, is a non-deliverable forward contract, in which banks buy forward dollars (book dollars today for delivery at a specified future date) in the local market for their clients and, simultaneously, sell equivalent dollars abroad, or vice-versa, so that on the delivery date they make a profit or loss, which is the difference between both the rates.

Globally, such deals are done in currencies that are not fully convertible to take advantage of —- or “arbitrage” —— the difference in the domestic forward rate and the NDF rate.

Contracts can range from one week to a year and Indian deals are mostly done in markets such as Hong Kong, Singapore and London (because their time zones match with the dealing room time here).

For example, the one-year forward rate in the domestic market is 46.70/$1 (46.05 is the rupee rate plus a 65 paise forward premium), but in Hong Kong, the same forward is quoting at 47.68/$1 —- a clear arbitrage of 98 paise.

The RBI can’t do anything to stop the trades since they are executed outside its jurisdiction, on foreign shores.

“It’s illegal so we can’t even talk about it. But it’s a peculiar situation because the rupee is not fully convertible here, but countries where these trades are settled have fully convertible currencies. Also, the RBI can’t just go ahead and legalise these trades because it would mean that they are jumping the regulation just because there are some players using this route,” said a senior official of the Foreign Exchange Dealers Association of India.

Forex watchers said such deals have primarily pulled the rupee down to 46.05 from 42.65 a month back, a fall of nearly 8%.

Dipti Deodhar, manager risk advisory, at forex consultant Mecklai & Mecklai, said hedge funds and foreign investors have made merry.

“NDF arbitarge has without doubt played a crucial part in the rupee weakness. Indian diamond companies with offices in markets like Hong Kong are also trading in NDF. Foreign institutional investors pulling out of India have also used this route to hedge bets,” she said.

Though clear estimates regarding the market are hard to find because of its unregulated nature, dealers said volumes have at least increased eight times from $100 million in 2003 to more than $800 million a day now.

“Volumes have increased definitely,” said a senior forex dealer with a US firm familiar with the market, who did not wish to be named. “There is a view in the overseas market that the rupee will weaken further. So banks armed with dollar supplies from RBI are buying greenbacks from the domestic market and selling it in the offshore market,” he said.

Volumes have increased because overseas forex dealers are increasingly looking at the rupee as another option for trade. And since the rupee is not fully convertible the best way to trade in the currency is through the NDF market.

However, it is not that the RBI is unwillingly feeding an illegal market. Dealers point out that if the RBI didn’t sell dollars in the local market, the short supply of dollars could weaken the rupee in double quick time because of the desperation by foreign funds to hedge their risks.

The RBI can’t do much from here except temper the flows but may be if push comes to shove, it may have to intervene in the overseas NDF market just like the Korean central bank did earlier this month.
r_joel@dnaindia.net