RBI Bans Participation in Non-Deliverable Derivatives Contracts

RBI Implements Strict Regulations on Rupee Derivatives

The Reserve Bank of India has instructed all banks not to indulge in non-deliverable derivatives (NDD) contracts relating to the rupee. The measure has been taken to curb speculative activity and stabilize the foreign exchange market in the country.

Definition of NDDs

Non-deliverable derivatives refer to those contracts which allow two parties to fix an exchange rate for future transactions but make payments only in the form of cash settlement and not currency. These contracts are normally settled in US dollars.

Reasons for Growth of NDD Markets

India being under restrictions on capital account, the foreign investors are unable to trade the rupees freely across the globe. Thus, such foreign investors started trading in contracts of rupees linked with offshore centers. The NDD markets in rupees thus evolved, though beyond regulation.

Market Risks and Concerns

Since the offshore markets are different from domestic markets in terms of rate discovery, there may be discrepancies between the two. Moreover, since the trading takes place based upon speculative purposes, volatility becomes higher and the currency becomes susceptible to global fluctuations.

Exam-Related Highlights

• NDD = cash-settled currency derivative contract
• No physical delivery of currency in transactions
• Typically used by foreign participants to trade on rupee
• Not subject to domestic regulations due to offshore nature

RBI’s Strategy and Objectives

This measure is adopted by the RBI with the intention of controlling the domestic rupee market through regulation. The central bank wishes to regulate and manage rupee exchange rates.