Covid-19 relief: RBI move to allow banks in NDF may stem volatility

Topics Coronavirus | RBI

As part of the regulatory package for dealing with the fallout of the Covid-19 pandemic on Indian financial markets, the Reserve Bank of India (RBI) announced today that “the time is apposite to remove the segmentation between the onshore and offshore markets” and accordingly it has been decided to permit banks in India which operate International Financial Services Centre (IFSC) banking units or IBUs, to participate in the non-deliverable forwards (NDF) market from June 1, 2020 through their branches in India, foreign branches or through their IBUs.

The provocation for this move is no doubt the recent large capital outflows from the markets that caused huge volatility in the forex markets – offshore NDF and onshore rupee. The volatility, widened spreads and drop in liquidity were more pronounced in the NDF markets and spilt over to the local forex market. If Indian banks were allowed to operate in the offshore markets, it would have perhaps have been possible to stem the volatility in the NDF market and the spillover effect - this could also have also facilitated more effective RBI intervention.

The RBI Task Force (August 2019) that studied the NDF markets extensively discussed the suggestion made to it to permit Indian banks to deal in the offshore market. The arguments made were: removing segmentation between onshore and offshore markets would improve liquidity and price discovery; there would be better customer pricing through increased transparency in the offshore market; there would be better access to information for local authorities and there would be a level playing field with overseas banks who freely deal in NDF markets. While the merits of the arguments were appreciated, the downside risk was that participation of Indian banks in NDF will improve liquidity in the NDF market and undermine the development of the onshore market. Also, completely removing the segmentation between the offshore and onshore markets would militate against the capital control measures in place; hence it felt that the measures to bring the NDF market onshore should precede allowing Indian banks to participate in NDF market.

Hence, while it is perhaps apposite to remove some segmentation between offshore and onshore markets to allow the Indian banks to effectively participate in the NDF markets to stem the volatility there and spillover effects to onshore markets, there is a need to have separate limits on the positions the banks can take in the NDF market within the overall position limit. This is comparable to the regulation that foreign banks operating in the local markets are not allowed to take off-setting positions (in their overseas branches) in the NDF markets.

deputy governor Usha Thorat had chaired the task force on offshore rupee markets, which had come out with its recommendations in August 2019

Dear Reader,

Business Standard has always strived hard to provide up-to-date information and commentary on developments that are of interest to you and have wider political and economic implications for the country and the world. Your encouragement and constant feedback on how to improve our offering have only made our resolve and commitment to these ideals stronger. Even during these difficult times arising out of Covid-19, we continue to remain committed to keeping you informed and updated with credible news, authoritative views and incisive commentary on topical issues of relevance.

We, however, have a request.

As we battle the economic impact of the pandemic, we need your support even more, so that we can continue to offer you more quality content. Our subscription model has seen an encouraging response from many of you, who have subscribed to our online content. More subscription to our online content can only help us achieve the goals of offering you even better and more relevant content. We believe in free, fair and credible journalism. Your support through more subscriptions can help us practise the journalism to which we are committed.

Support quality journalism and subscribe to Business Standard.

Digital Editor

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel