About Non-Deliverable Derivative:
- An NDD is a derivative contract where two parties agree on a future exchange rate for the rupee, but settle the difference in cash, usually in US dollars.
- Reason for formation: As India has capital controls, offshore investors can’t freely trade in the rupee in physical form. This led to the creation of the NDD markets in the rupee.
- Participating Parities: The NDD market is widely used by foreign investors, hedge funds and global banks who cannot freely access and play in the Indian rupee market.
- These trades take place offshore, outside the control of the RBI.
- This often acts as a price discovery mechanism for the rupee, even influencing expectations before Indian markets open.
- Issues with NDD
- Distort Price Discovery: These instruments have long been criticised for distorting price discovery.
- Used For Speculation: Some participants would cancel and re-enter contracts to take advantage of favourable movements, effectively turning hedging tools into speculative instruments.
