What is a non-deliverable forward (NDF) and why is it used for emerging market currencies?

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AcadiFi · Accepted Answer

An NDF is a cash-settled FX forward in which no physical exchange of the underlying currency occurs. It exists precisely because some emerging market currencies have capital controls.

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Consider Hargrove Exports in London expecting a 450 million INR receivable in 3 months. A standard deliverable forward would require Hargrove to receive actual INR and convert — but as a UK entity, Hargrove can't easily hold INR in a domestic bank account due to RBI rules. Instead, Hargrove enters an INR/USD NDF with Bellmont FX Ltd. struck at 82.50 INR per USD.

At maturity, no rupees change hands. Both parties reference a fixing rate (typically the RBI reference rate or a Reuters fix), compute the gain or loss versus the strike, and settle the net difference in USD. If the fixing prints at 83.80, Hargrove effectively sold INR at a worse market rate but receives USD compensation from the NDF counterparty for the difference.

Economically, the NDF replicates the FX hedge even though no rupees move internationally. It's the only practical hedging tool for many multinationals. NDFs trade OTC in offshore centers like Singapore and London, and the offshore NDF-implied rate can diverge meaningfully from the onshore deliverable rate during capital-control stress — a phenomenon Chinese yuan CNH-vs-CNY made famous.

What is a non-deliverable forward (NDF) and why is it used for emerging market currencies?

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