Offshore forwards and exchange rate transmission in emerging markets

Focus

We study how trading in offshore non-deliverable forward (NDF) markets for emerging market currencies transmits to onshore spot exchange rates. We also assess how capital controls and the ability of domestic banks to trade offshore affect that transmission. Our analysis uses transaction-level data on NDF trades cleared through LCH ForexClear for 10 emerging market currencies from 2014 to 2025.

Contribution

This paper is the first to analyse NDF price formation using signed, transaction-level order flow rather than quoted rates or aggregate trading volumes. We develop a model in which two forces operate separately: offshore demand to gain currency exposure, which moves prices and the gap between offshore and onshore rates together, and the cost faced by banks that intermediate between offshore and onshore markets, which moves that gap relative to prices. Four episodes in which regulators changed banks’ access to offshore NDF markets – in China, Malaysia and, twice, in India – illustrate both channels at work.

Findings

A $1 billion increase in offshore dollar demand moves the onshore exchange rate by about 10 basis points within minutes, and the offshore forward rate by about 18 basis points. Offshore trading also widens the gap between offshore and onshore prices, in line with our model’s predictions. This gap narrowed, for instance, when Indian banks were allowed to participate in offshore markets in 2020 and widened again when that access was restricted in 2026. The results show that offshore trading affects onshore exchange rates even where capital controls limit direct access to the domestic market, and that how much of this pressure reaches the domestic market depends on how tightly banks’ cross-market activity is regulated.

Abstract

We study how offshore non-deliverable forward (NDF) markets transmit exchange-rate pressures to domestic currency markets. Using unique transaction-level data on the universe of centrally cleared NDFs for ten emerging-market currencies over 2013–2025, we show that offshore NDF order flow moves both offshore forward and domestic spot exchange rates and widens the offshore–onshore forward spread. To our knowledge, this is the first transaction-level evidence on price formation in these markets. A $1 billion long-USD order flow depreciates the domestic spot rate by about 10 basis points and the offshore NDF rate by about 18 basis points. The spot impact is larger when dealer balance sheets are tight. Policy episodes in the Chinese renminbi, Malaysian ringgit, and Indian rupee show how changes in offshore speculative activity and arbitrage between offshore and onshore markets affect the spread and domestic exchange rates. We rationalize these findings with a model in which offshore demand pressure generates NDF order flow, dealers hedge inventory through domestic spot markets, and capital controls limit intermediation between offshore and onshore forward markets.