Normal foreign exchange risk management tools such as forward contract involve delivery on the assumed due date. These are permitted in all developed and developing foreign exchange markets. But to hedge the risk arising out of dealing in currencies having capital controls by nonresidents, foreign exchange markets, the largest and most innovative among the markets, have evolved new products such as non deliverable forwards and swaps. This article explains the salient features of such products, the size and the impact on the normal foreign exchange markets.

In the 1970s, during the Middle East oil crisis, US dollars accumulated outside USA created the euro dollar market enabling both depositors and borrowers in these funds to enjoy terms better than that for US dollar funds in US market. The huge ECB market, practically outside Central Bank controls, developed therefrom.

Foreign exchange market is the largest market among the various financial markets. Innovation is the key for success and survival here. Currencies which are not freely traded and are subject to capital controls but whose movements are aligned to international rate movements naturally create a scope for trading in such currencies outside their homelands. A market for non-deliverable forwards in foreign exchange developed to meet this requirement. The non-deliverable "funds" market however does not compare with Eurodollar market any further. While trading in such funds take place outside the homeland, they cannot be delivered and hence have to be netted and settled in a free currency on due dates.

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