The backdrop is a bruising spell for the rupee. The currency sank to record lows in March as conflict-linked fears over energy supplies drove oil prices higher and triggered capital outflows from domestic assets. That slide left the central bank confronting a familiar dilemma: allow the exchange rate to absorb the shock or step in more forcefully to curb disorderly moves in a country heavily exposed to imported crude. Reuters reported that the rupee hit a record low around mid-March before the Reserve Bank stepped up support measures as traders fretted over the growth and inflation fallout from elevated oil prices.
Against that backdrop, the central bank moved on March 27 to tighten rules around banks’ foreign-exchange exposure. It imposed a $100 million cap on net open dollar-rupee positions in the onshore market and restricted banks’ ability to deal in non-deliverable forwards, measures aimed at curbing arbitrage between local and offshore markets that officials believed had become destabilising. Governor Sanjay Malhotra has since said the steps were temporary rather than a long-term retreat from market development or rupee internationalisation, but the regulatory intent was clear: volatility linked to rapidly expanding positions would no longer be tolerated.
Bloomberg reported on Sunday that a senior Reserve Bank official criticised market makers for aggravating the rupee’s weakness during the Middle East tensions, reinforcing the view that policymakers see some trading strategies not merely as opportunistic but as harmful to market functioning. Bloomberg had earlier quoted Deputy Governor T. Rabi Sankar as saying the arbitrage build-up led to an “artificial drying up” of dollar supply in the market, affecting prices. That language is notable because it suggests the regulator believes the issue went beyond normal speculative behaviour into a form of distortion that reduced liquidity when it was needed most.
Market participants have broadly accepted that the positions were sizeable. Reuters, citing industry estimates and clearing data, said consensus had settled around roughly $40 billion of arbitrage exposure, much of it built across the onshore and non-deliverable forward markets. By early April, banks had exited the bulk of those trades ahead of the Reserve Bank’s April 10 deadline. Clearing house data pointed to around $36 billion in NDF trades between April 1 and April 7, seen largely as part of the unwind. That process helped support the rupee at points, but it also created other distortions, including sharp moves in forward premiums and strained hedging conditions for importers.
For companies exposed to foreign-currency liabilities, the clean-up has been costly. Reuters said one-year dollar hedging costs jumped sharply, at one point posting the steepest rise since the global financial crisis, as importers rushed to lock in cover and market liquidity thinned. That matters because the regulatory cure, while aimed at curbing speculative pressure, can tighten financing and risk-management conditions for genuine commercial users. It is one reason some dealers have privately argued that while the central bank was justified in tackling excessive positioning, abrupt curbs can deepen dislocations in a market that depends on continuous two-way activity.
Still, the Reserve Bank appears willing to accept short-term disruption in exchange for regaining control of the policy signal. The rupee rallied through parts of early April as arbitrage positions were unwound and a temporary US-Iran ceasefire drove oil lower, with the currency at one stage strengthening into the 92-93 range against the dollar. Yet that recovery proved fragile. On April 9, the rupee slipped again as doubts over the truce resurfaced, Brent crude rebounded and wider risk sentiment weakened. For policymakers, that sequence underscored how quickly external shocks can overwhelm domestic market plumbing if positioning is allowed to build unchecked.
Broader lessons are now emerging for the financial system. One is that India’s increasingly connected currency market, spanning domestic forwards, exchange-traded futures and offshore NDFs, can improve price discovery in calm conditions but amplify stress when geopolitical shocks hit. Another is that the Reserve Bank remains prepared to intervene not only through spot-market support but also through conduct-based regulation when it thinks market behaviour is aggravating weakness. That stance may temper speculative excess, but it also raises questions about how much freedom banks will have to intermediate risk in future episodes of volatility.
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