As you know that our INR has depreciated a lot, from 2022 it has depreciated by 20% and in 2026 alone it has depreciated by almost 7% this is a rapid depreciation of an emerging market currency. When the FII's invest in emerging market they take in account the depreciation of currency of the market they are trading in. If they don't account for currency depreciation, then their profits will reduce significantly.
What is NDF?
NDF stands for Non-Deliverable Forwards which means no physical delivery of the underlying is taken place instead it is cash settled between both parties and usually it's in USD. NDF is done in emerging market currencies where the currency trading terms are stricter for example Indian Rupee, Brazilian Real, Chinese Yuan. The NDF contracts are used to hedge against the currency risk by the Institutions which lacks access to domestic markets for the particular currency as well as for speculative gain in the restricted currencies. The NDF contracts are traded in major financial markets such as London, New York, Singapore etc.
In the NDF contract specify the currency pair, contract size amount, fixing date, settlement date, and NDF rate.
Let's suppose if one party agrees to buy Indian Rupee (sell dollars), and the other agrees to buy U.S. dollars (sell Rupee), then there is potential for a non-deliverable forward between the two parties. They agree to a rate of 90 on $1 million U.S. dollars. The fixing date will be at a particular date, with settlement due shortly after the fixing date.
If in one month the rate is 88, the Rupee has increased in value relative to the U.S. dollar. The party who bought the Rupee is owed money. If the rate increased to 93, the Rupee has decreased in value (U.S. dollar increase), so the party who bought U.S. dollars is owed money.
RBI's Notification on 1st APR 2026 regarding NDF
On 1st RBI said in a notification as follows:
#1 Authorized Dealers shall not offer non-deliverable derivative contracts involving INR to resident or non-resident users. While the Authorized dealers can offer deliverable contracts, but the authorized dealers must ensure that client do not hold offsetting positions in the offshore NDF market.
#2 Restriction on cancellation and rebooking of FX derivative contracts which allowed market participants to roll over or reprice positions under the guise of hedging, this closes a long-standing loophole but in reality, often facilitated speculative positions.
#3 Authorized Dealers will not undertake any foreign exchange derivative contract involving the Indian unit with their related parties.
Why RBI took action?
Since RBI has limited the exposure of the Authorized Dealers to $100 million the authorized dealers started transferring exposure to corporates. This gave rise to a loophole through which corporates could indulge in arbitrage between the domestic and international markets which was a speculation point and put extra pressure on Rupee.
RBI took these steps as it wanted that hedging against the currency is fine, but speculation is not.
How FII (FPI) works in India?
Suppose FII invested $100 in the Indian market for an expectation of 10% return, let's assume that they invested at 90 Rupees to a dollar then after few months INR depreciated and starts trading at 95, when the currency depreciated by 5-6% a year along with that taxes and transaction cost taking into to account their gain is becomes less than 5% which is very low so they hedge against the currency fall since our currency is quite volatile.
After the regulation were tightened by the RBI the volume dropped in our Indian market because the FII's were not active due to restriction on currency hedging. This is temporary measure taken by RBI as Rupee was a free fall mode and registered a life low of nearly 97 to the Dollar.
Why RBI took such a step?
If you notice till date this year FII's have sold worth 348,333 Crores last year in 2025 it was 306,419 Crores and the year before in 2024 it was 302,435 Crores after carefully examining the selling figures for the last two years FII's have sold more in this year and there is still time left in this year.
RBI cannot impact the market directly, but they have the power to control the currency. Foreign outflow by the FII's is primarily in Dollars due to which our Rupee becomes weak as well as weak Rupee creates strong dollar this is a cycle which ultimately depletes the forex reserve. Rupee has low demand this is why its weak.
West Asia war situation the demand for Dollar increased, as well as continuous selling by the FPI put more pressure on Rupee as there is almost no demand for Rupee internationally as majority of the trades are settled in Hard currency such as Dollar, Euro, British Pound while Dollar being the dominant one.
This is a temporary restriction Put by RBI due to which the FII's are not that active in the Indian market, and you must have noticed the fall in selling figures in FII's selling. Once these measures are lifted up, we can see Rupee breaching 100 mark against the Dollar as well as the FII's resuming selling.
Why FII's are leaving India?
Many people are thinking, that FII's are leaving India primarily due to high Taxes such as LTCG and STCG but the main culprit is the INR weakness as they don't have proper hedging instruments and Rupee is very much volatile, and along with they have to pay lot of taxes on conversion.
Let's understand this with an example why they are leaving India, suppose an American Hedge Fund wants to invest in India when they bring money, they bring in Dollars then its converted into Rupees and this Rupees is invested in the stock market and they also get return in Rupees let's say they gained 10% in Rupee terms in which they have to pay LTCG/STCG depending upon the holding along with currency conversion charges.
When Rupee has depreciated their returns and at the same time Dollar has appreciated so their profits are getting hit on both sides and very much reduced. There is also scarcity of instruments that the FII's can hedge the currency depreciation risk. This is the primary reason for FII's to abandon India.
Strength of Dollar:
The Picture I have shared below is taken from the US Federal reserve, which shows the strength of US dollar on a broader index. If you see the data from the last 6 months the Dollar Index is strengthening which means the demand for Dollars is rising that signals that investors are pulling out money from the risky asset class and buying Dollars, this is why you must have noticed that the Crypto currencies such as Bitcoin and Ethereum have fallen a lot in the last 6 months.
Final Thoughts:
The FII's exits has many reasons but the most prominent is the weak currency, so until Rupee stabilizes the FII's will continue selling because they its easier for them to find new opportunities elsewhere rather than investing in India where there are restrictions on hedging, high taxes as well as a volatile currency. Also, we are a net importing nation since out Net Imports is much greater than Net Exports this creates Fiscal Deficit and creates additional pressure on Rupee so unless we take care of the widening Fiscal Deficit it's very much difficult to stabilize Rupee.
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