The Reserve Bank of India (RBI), in a significant regulatory move on 22 September 2025, amended its Master Direction on Risk Management and Inter-Bank Dealings to allow Standalone Primary Dealers (SPDs), categorised as Authorised Dealer Category-III (AD Cat-III), to transact in non-deliverable derivative contracts (NDDCs) involving the Indian rupee.

Earlier, only Authorised Dealer Category-I (AD Cat-I) banks, particularly those with International Financial Services Centre (IFSC) Banking Units (IBUs), were permitted to do so.

This article examines what this change entails, the rationale behind it, its potential impact, and the risks, as well as policy considerations.

What are Rupee Non-Deliverable Derivatives (NDDCs) & Who Were Previously Eligible?

NDDCs (often also called Non-Deliverable Forwards/Swaps, etc.) are derivative contracts where one party hedges or takes a position on a future rupee exchange rate, but settlement is done in a freely convertible currency such as the US dollar rather than physical delivery of rupees. They are widely used by non-residents and residents alike when access to deliverable forward markets is limited or when seeking offshore risk management.

Before this change:

Only AD Cat-I banks operating inside India, particularly those with an IFSC Banking Unit, could engage in rupee NDDCs.
SPDs, classified as AD Cat-III, were not eligible to participate in such derivative contracts involving non-resident counterparties or offering to both residents and non-residents under those instruments.

The New RBI Notification: What Has Changed

The RBI notification (Circular No. RBI/2025-26/78 A.P. (DIR Series) — Circular No. 10) brings the following key changes:

SPDs, when authorised as AD Cat-III, are now explicitly allowed to transact in rupee NDDCs with both residents and non-residents.
SPDs will now stand alongside AD Cat-I banks (with IFSC IBUs) and overseas banks in being eligible to offer rupee NDDCs.
The change is effective immediately from the date of the notification (22nd September 2025).

Why Did RBI Do This? Motives and Rationale

Analysing both the public statements and background, several motivations underlie this policy shift:

Deepening the Rupee Derivatives Market
Broadening the base of market participants helps deepen liquidity and pricing efficiency. SPDs have historically been active in government securities (G-Sec) markets; enabling them in derivatives adds more players to currency risk-management tools.
Improving Hedging Access for Businesses
Many corporates, importers/exporters, and financial institutions (both resident & non-resident) rely on hedges against currency risk. Allowing more entities to offer NDDCs can improve availability and reduce costs of hedging.
Reducing Offshore Reliance & Arbitrage
There has been substantial activity in offshore markets (e.g. Singapore, other financial centres) in rupee NDFs. Wider participation by domestic regulated entities could help align onshore and offshore rates, reduce arbitrage where it is distortive, promote stability.
Regulatory Cohesion & Flexibility
With previous permissions granted (in August 2022) allowing PDs to offer foreign exchange facilities, this is part of a broader pattern of enabling more flexibility in foreign exchange and derivative markets under regulated frameworks.
Managing Rupee Volatility
RBI has recently increased its interventions in the NDF markets as anxiety around global headwinds (e.g. US tariffs, slowing growth, volatile capital flows) have put pressure on the rupee. Allowing more regulated entities to operate in this space helps the central bank in promoting orderly conditions.

The Expected Impact: Pros and Cons

Below is a table summarising the expected positive effects and potential risks or costs of this policy change.

Expected Benefits vs Potential Risks of SPD Participation in Rupee NDDCs

Aspect	Potential Benefits	Potential Risks / Concerns
Liquidity & Market Depth	Increased liquidity in rupee NDDCs thanks to more participants; better price discovery.	If market depth is weak initially, SPDs may face higher risk; illiquidity could lead to volatile spreads.
Cost of Hedging	More competition could reduce spreads and hedging costs for end-users.	Operational or capital costs for SPDs establishing NDDC desks may be high; costs may pass on to users initially.
Onshore-Offshore Arbitrage	Reduced gaps between offshore NDF rates and onshore forward/OTC rates; less scope for arbitrage.	Arbitrage might shift elsewhere or adapt, possibly leading to new kinds of mispricing.
Regulatory Supervision	More transactions under regulated, domestic supervision; better tracking of exposures.	Risk of regulatory arbitrage; possibility of excessive risk taking by SPDs if oversight is weak.
Exchange Rate Volatility	Better tools for corporations to hedge; more domestic channels; potential dampening of volatility.	If many positions are one-sided (e.g. heavy import hedging), could still exacerbate volatile moves; counterparty credit risk.
Foreign Participation & Investment	Broader access for non-residents, possibly attracting more foreign investors seeking hedging.	Capital flow effects; regulatory complexities regarding foreign counterparties; potential for misuse or speculative abuse.

Data & Market Trends: A Look at Recent NDF Activity

To understand the context better, here are some recent trends in the rupee NDF market:

In December 2024, NDF volume for USD/INR at offshore centres rose to $161 billion, a sharp rise (140%) from the previous year. Much of this was driven by arbitrage between offshore NDF and onshore deliverable forwards when divergences in rates appeared.
RBI interventions are being detected in both NDF and onshore spot markets. For example, when the rupee weakened significantly (say, crossing ~₹ 88.40 per USD), the RBI sold dollars in the NDF market in past instances to stem depreciation.
Implied volatility for one-month rupee rates has recently dropped to six-month lows, indicating that markets believe the rupee may be stabilizing somewhat. Regulatory changes like this one likely contribute to anchoring expectations.

These trends suggest that the rupee NDF market has been under stress (due to global uncertainty, trade policy shifts, etc.), and demand for hedging has been rising. The policy shift allowing SPDs could help accommodate some of this demand domestically.

How SPDs Fit Into India’s Foreign Exchange & Derivatives Regulatory Structure

To appreciate the significance, it helps to understand what SPDs (Standalone Primary Dealers) are, and what being AD Cat-III implies:

Standalone Primary Dealers are financial institutions, approved by RBI, whose primary activity is dealing in government securities. They contribute to liquidity in the government securities market, help in borrowing programmes, and act as market makers in G-Sec. They are distinct from banks in that while they can hold banking licences or other permissions, their core business is in the government debt markets.
AD Category III (AD Cat-III) is a classification under the RBI’s Authorised Dealer framework, which gives certain permissions in foreign exchange transactions but with more limited scope compared to AD Cat-I. Under AD Cat-III, entities cannot deal in broad forex transactions beyond a certain scope, or with non-resident parties, unless specifically permitted. Under this change, SPDs that are AD Cat-III get the specific permission to deal in rupee NDDCs.
The Master Direction on Risk Management and Inter-Bank Dealings (2016) provides the regulatory foundation, specifying which entities can enter into what kind of FX or derivative transactions, their exposure limits, documentation, counterparty risk, etc. The current amendment is part of that regulatory master direction.

Challenges, Risks & What Needs Careful Monitoring

While this policy move brings many potential advantages, there are areas that require close oversight and risk management:

Counterparty Risk: SPDs entering into derivative contracts must manage counterparty credit risk, especially if dealing with non-residents or offshore entities.
Operational Infrastructure: SPDs will need robust systems for risk monitoring, settlement, accounting, compliance, and know-your-customer / anti-money-laundering (KYC/AML) procedures.
Regulatory and Accounting Challenges: How SPDs mark to market, hedge, or maintain collateral, and how these derivative exposures are disclosed will matter both for financial stability and for inter-institutional trust.
Potential for Speculative Excess: If many participants take large one-sided positions (e.g. importers hedging heavily or speculators betting), there could be strain on reserves or on systemic risk.
Interaction with Onshore FX and Capital Controls: Even though NDDCs settle in foreign currency, these markets affect onshore exchange rate expectations. Discrepancies between onshore forward, onshore spot, and NDF rates can lead to capital flow distortions if arbitrage becomes too large or if restrictions are inconsistent.
Transparency and Data Availability: For market participants (including regulators), visibility on open interests, volumes, and positions in NDF/NDDC markets will be essential to understand systemic exposures. Lack of data could exacerbate risk.

Comparative & Global Perspective

Looking outward, many emerging markets with partially convertible currencies permit non-deliverable forwards or similar instruments so that offshore participants or those constrained by local rules can hedge. The experience globally suggests:

A properly regulated NDF market can help in absorbing shocks, allowing exporters/importers to hedge, and in smoothing volatility.
But, excessive divergence between onshore and offshore rates can lead to arbitrage behavior, capital flight or speculative positioning, especially when onshore capital controls are in place or when market access is uneven.
Transparency, regulatory oversight, capital adequacy, and hedging rules matter a lot in ensuring that the market remains orderly.

India’s decision to allow SPDs to participate follows from similar liberalization trends elsewhere (albeit India’s onshore FX and capital flows regime remains more tightly controlled than many fully open economies).

Quantitative Impacts & Projections

To illustrate what we might expect in quantitative terms, here is a projected impact summary based on recent market data and the new policy:

Projected Market Impact Measures Post-SPD Entry into NDDCs

Measure	Before SPD Entry	Projected After SPD Entry	Assumptions
Monthly NDF/Rupee volume (offshore + onshore)	~$150-170 billion (offshore) in peak months; large share speculator/arbitrage driven.	Could increase by 10-30%, as SPDs bring new liquidity and hedging demand domestically.	Assumes SPDs can attract business and build dispersed client base; no large regulatory friction.
Onshore vs Offshore rate arbitrage spread	Periods of significant divergence (in forward premiums etc.).	Spread expected to narrow, especially in forward premiums, as domestic liquidity absorbs some of offshore pressures.	Assumes effective participation by SPDs and alignment of documentation/pricing standards.
Hedging cost for corporates/importers/exporters	Relatively higher due to limited providers and risk premium.	Could reduce somewhat as more providers compete, spreads tighten, more hedging options.	Assumes adequate competition and transparency; cost of setting up SPD operations not excessively passed on.
Exchange rate volatility (short-term)	High in times of external shocks; implied volatilities have been elevated.	Likely to moderate somewhat over time, especially for short-to-medium tenors.	Requires that hedging demand is balanced; that liquidity is reliable.

Conclusion

The RBI’s move to allow Standalone Primary Dealers, under the AD Cat-III category, to participate in rupee non-deliverable derivative contracts is a meaningful step in liberalizing and deepening India’s foreign exchange derivative ecosystem. It is consistent with broader trends in enhancing hedging access, smoothing volatility, and reducing dependence on offshore NDF markets.

If implemented well, this change can bring lower hedging costs for firms, better liquidity, improved hedging choices, and help in narrowing the often-sharp arbitrage gaps between onshore and offshore markets. However, achieving these outcomes depends critically on sound risk management by SPDs, strong regulatory oversight, transparency in markets, and ensuring that the new permissions do not create excessive speculative exposure or unintended distortions.

In short, this policy change strengthens the rupee derivatives framework and has the potential to improve stability and efficiency, but its ultimate success will depend on how market participants adapt, how regulators manage risks, and how external shocks are handled in the coming months.

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