Whether The Reserve Bank’s Intervention In NDF Market Will Stop Depreciation Of Rupee Against US Dollar ? The Reserve Bank of India is increasingly relying on interventions in the non-deliverable forwards (NDF) market to stabilise the rupee (which hit to high low of ₹84.50 against 1 US$ in recent times), moving away from traditional methods in the local over-the-counter (OTC) spot market. In a notable shift, the RBI is targeting the NDF market to manage rupee volatility while safeguarding its foreign exchange (FX) reserves. Traditional interventions in the OTC spot market are being complemented by cost-effective NDF transactions, which settle differences between contracted rates and prevailing spot prices. This approach emerged as a strategic move to influence local market sessions preemptively, especially during volatile events like the Iran-Israel as well as Russia-Ukraine confrontation. The RBI’s shift to NDF interventions is a tactical move to stabilise the rupee without depleting large amounts of FX reserves. This not only boosts market confidence but also highlights the central bank’s innovative measures to manage short-term volatility effectively. ◼️What Is Non-Deliverable Forward Contract? An NDF is similar to a regular forward foreign exchange contract, except at maturity the NDF does not require physical delivery of currencies, and is typically settled in an international financial center in U.S. dollars. A forward foreign exchange contract is an obligation to purchase or sell a specific currency on a future date (settlement date) for a fixed price set on the date of the contract (trade date). For an NDF contract at maturity, settlement is made in U.S. dollars the other currency, usually an emerging market currency with capital controls, is "non- deliverable”. Thanks for reading….
The move to NDF markets is a smart way to manage currency fluctuations while keeping FX reserves intact.
Aittreya R S
4mo
A 2/2 What SGB Holders Should Do Given the current circumstances, SGB holders are in a unique position. By accepting gold and selling it in the open market, they can potentially realize significant gains, as the metal’s value has surged. This approach not only maximizes their returns but also highlights the flaws in the RBI’s risk management strategy. Lessons from the SGB Saga Lack of Risk Mitigation: By benchmarking SGBs to gold without adequate hedging mechanisms, the RBI exposed itself to enormous price risk—a fundamental misstep in risk management. Conflicting Practices: While the RBI actively regulates the gold industry and preaches risk management, its own actions in this case did not follow the principles it imposes on others. Burden on Taxpayers: Any financial strain from this scheme ultimately affects the economy and taxpayers, undermining the credibility of the RBI’s policy decisions. The Takeaway Left to the reader
Aittreya R S
4mo
Just wondering whether RBI is hedging or speculating ?
Aittreya R S
4mo
2/2 Encourages Speculative Behavior: The introduction of financial futures, rather than curbing speculative excesses, incentivizes more speculative activity, amplifying risks in an economy where hedging tools are primarily needed for trade facilitation and stability. Fails to Address the Root Cause: The chaos of 2008 was not due to the absence of currency derivatives but the reckless selling of exotic derivative products by private banks without sufficient regulatory checks. Allowing currency derivatives merely added another layer of complexity instead of resolving these underlying issues. A Missed Opportunity for Reform: The RBI could have used the 2008 episode as an opportunity to strengthen regulatory oversight, enforce stricter compliance on banks, and focus on simpler, more transparent hedging tools tailored to the needs of Indian businesses. Instead, it introduced currency derivatives—a product that benefits speculators more than the real economy—into an already cautious financial ecosystem. India’s economy needs stability-focused policies, especially in its currency markets, given its restrictions on free currency flows.
Aittreya R S
4mo
1/2 The Reserve Bank of India (RBI) opened Pandora’s box by introducing currency derivatives trading in Indian exchanges, a move that seems fundamentally misaligned with India’s economic structure, which lacks full capital account convertibility. This decision appears to have been a reaction to the 2008 chaos, where private banks sold exotic forex options to exporters and importers, resulting in massive financial losses for businesses unfamiliar with the inherent risks. Instead of reigning in the private banks responsible for this debacle, the RBI merely imposed fines on a few entities while leaving the door open for the broader use of speculative instruments like currency derivatives. This approach overlooked the real issue: the misuse of complex derivatives by institutions and the lack of adequate safeguards for market participants. Why Currency Derivatives Were a Misstep: Misaligned with Economic Reality: India operates under restricted foreign currency flows, with no full capital convertibility. Financial futures, which thrive in economies with liberalized foreign exchange regimes, introduce volatility that India’s economy may not be equipped to handle. 2/2
Aittreya R S
4mo
By issuing bonds benchmarked against gold prices with tax-free capital gains and a 2.5% annual interest, the RBI essentially shorted 140 tonnes of gold, collecting ₹70,000 crores. This seemed like a masterstroke at first but has now backfired spectacularly, with gold prices soaring in 2024. The RBI faces an estimated notional loss of ₹40,000 crores. To manage this liability, the central bank repatriated 100 tonnes of gold and is now pushing bondholders to accept physical gold instead of cash settlements. In hindsight, the RBI's strategy appears to have overlooked manageable, long-term measures for tackling gold demand—such as enhancing financial literacy or creating alternative gold-backed investment products. Instead, it pursued a high-stakes financial maneuver that has exposed it to massive risks.
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4moA 1/2 The Reserve Bank of India has had its share of questionable policy decisions, one of which is the Sovereign Gold Bond scheme. While the intent may have been to reduce physical gold imports and provide a financial alternative for gold investments, the execution raises significant concerns about prudence and risk management. Under the SGB scheme, the RBI raised approximately ₹70,000 crores by issuing bonds benchmarked against gold prices. In essence, the RBI "shorted" 140 tonnes of gold, promising returns linked to gold price appreciation, exempting capital gains, and offering a 2.5% annual interest payout. While this may have seemed like an innovative way to monetize India's appetite for gold, it exposed the central bank to massive price volatility risks. This year, with gold prices skyrocketing, the RBI finds itself staring at an approximate notional loss of ₹40,000 crores. To mitigate this liability, it repatriated 100 tonnes of gold, a move signaling desperation rather than strategic foresight. Furthermore, the RBI is now compelling SGB holders to accept physical gold instead of cash settlements—a stark departure from the original premise of the scheme. A 2/2