NDF market weigh on on-shore currency derivative market

The Reserve Bank of India's steps to curb volatility in currency derivatives may have reduced volumes, but the trend in offshore currency forward market for Indian rupee continues to set the tone for trades in on-shore rupee derivatives.

According to treasury executives, movements in the non-deliverable forward (NDF) market and domestic currency markets are closely linked. While there is no specific pattern, NDF market rates provides lead for action in on shore currency derivative market. For example, the trend in NDF (which is almost round the clock platform) provides leads for opening trades in domestic currency market.

NDF is an offshore currency forward market wherein delivery of contracts does not take place on maturity. Those involved in trades only settle the difference amount, be it profit or loss.

The volumes in NDF market has been impacted by the activity level in onshore market, tracking volatility and liquidity squeeze. RBI took steps to curb liquidity (rupee resources) which it is felt were being used currency speculation.

RBI also barred banks for proprietary trading in currency futures. They could trade only on behalf of clients.

Treasury executives and currency dealers said following these restrictions, the volumes in on shore market have come down. Consequently, the NDF market also witnessed a dip in turnover.

Being a shallow market, the volatility has gone up, which is mirrored in the NDF market trend as well, said a head of treasury with a private sector bank.

NDF being an unregulated market, it is difficult to get any data on volumes. NDF serves two purposes -- arbitrage and hedging.

RBI monitors the NDF market. The existence of the NDF market has influenced India's foreign exchange market, but it has influenced much more in times of volatility.

During the first quarter review media interaction, RBI governor D Subbarao had said, "It will be a better world for us if there is no NDF market, but we cannot wish it away."