Rupee volatility: Muzzle price signals if necessary but act to close onshore-vs-offshore market gaps

To defend the currency, the Reserve bank of India (RBI) sold dollars heavily from its reserves, which fell by $30.5 billion in March. Crude oil at $115 per barrel was adding further strain.

RBI then mounted a bold two-step intervention. It first capped banks’ net open rupee positions at $100 million. That led banks to simply transfer their exposure to corporates and hedge funds, which then used the arbitrage between onshore and offshore rates to press further against the rupee. RBI then banned banks entirely from offering rupee non-deliverable forward (NDF) contracts to any client and forbade the rebooking of cancelled ones. The rupee responded with its largest single-day gain in over 12 years.

These gaps make RBI’s stiff action look justified. But there are also questions that outlast any single crisis.

Can a price signal be gagged? An NDF is a derivative contract, settled in dollars, traded in financial centres such as London, Singapore, Hong Kong and Dubai. Because the rupee is not fully convertible, non-residents who wish to hedge or speculate on the rupee use NDFs instead of the onshore market. Daily NDF volumes globally are estimated to be $150 billion, making the market large, liquid and informative.

Market bids are a form of price discovery. When the NDF market signals sharp rupee weakness, it yields information about capital flow expectations, oil prices, global risk appetite and India’s current account trajectory. That signal may be uncomfortable and exaggerated at times by herd behaviour or thin liquidity. But suppressing it does not make the underlying pressures disappear. It merely removes the thermometer while the fever persists.

RBI’s intervention was necessary to prevent a disorderly overshoot. But it is not a verdict that the NDF market has no legitimate role.

The RBI Task Force on Offshore Rupee Markets, chaired by Usha Thorat in 2019, confirmed that the influence between offshore and onshore rates is bidirectional in normal times. It turns unidirectional, with NDFs driving the onshore market, only during episodes of stress like the taper tantrum of 2013.

But in general, these NDFs are not always the tail wagging the dog. Excessive speculation in thin, one-sided conditions can cause damage. But the right response is to deepen the onshore market and not permanently gag offshore signals.

The rupee’s weakness was manifest in the exodus over two years of funds pulled out by foreign institutional investors. In 2025-26, the outflow on this account was a record ₹1.6 trillion-odd, reflecting a global risk-off sentiment, geopolitical anxiety amid the Iran war and concerns over India’s current account as well as investment policy. NDF signals should be seen in this light.

The Thorat panel had recommended attracting NDF volumes onshore through the GIFT City’s International Financial Services Centre (IFSC), simpler KYC norms, extended trading hours and permitting of hedging up to $100 million without requiring proof of exposure.

Brazil and Indonesia have partially succeeded in similar efforts. Since both countries are commodity exporters with structural trade surpluses, they have organic dollar inflows, which makes it feasible to offer onshore liquidity and pricing.

India lacks this advantage. With a persistent current account deficit (CAD), the rupee faces structural depreciation. Non-residents also have little incentive to bring hedging onshore when India’s tax treatment of derivatives is less favourable than offshore centres and compliance costs higher.

In addition, the regulatory environment can change overnight, as the latest move shows. The liquidity chicken-and-egg problem is real: without non-resident participation, onshore markets cannot deepen; without deep onshore markets, non-residents will not come.

India runs a persistent current account deficit and has higher inflation than its major trading partners. So, some rupee depreciation is not only inevitable but desirable. It maintains export competitiveness and acts as a system-wide shock absorber when external conditions deteriorate.

As for the next steps, first, the NDF ban should be temporary. RBI should get back to the Thorat taskforce recommendations. Deepen IFSC trading, ease non-resident access, harmonize tax treatment and extend onshore trading hours.

Second, accelerate the rupee’s internationalization. Only about 5% of India’s trade is settled in rupees. The more trade is invoiced and settled in rupees, the less the NDF market would matter. Every step that reduces structural dollar dependence would reduce the speculative demand that feeds it.

Third, we need strong foreign direct investment (FDI). Net FDI has turned negative, which is unacceptable. It is the only durable counterweight to CAD-driven rupee weakness. Tax and regulatory policy must tilt in favour of patient capital.

Fourth, currency stability rests on macroeconomic fundamentals—the fiscal balance, inflation and growth. Policy predictability is itself a form of currency defence.

The NDF market is a symptom, not the disease. The cure lies in a deeper onshore market, an internationalizing rupee and an economy that earns the world’s confidence rather than having to buy it with reserves.

The author is senior fellow with Pune International Centre.