Pressure on the rupee is poised to intensify after the Reserve Bank of India ordered banks to sharply cut net open rupee positions in the onshore market, forcing a scramble to unwind large arbitrage trades that had linked domestic and offshore pricing.
Bankers have warned that the adjustment could amplify volatility, strain treasury books and unsettle corporate hedging activity even as the central bank seeks to restore control over the currency market. The trigger was the RBI’s directive issued late on March 27 requiring lenders to cap their net open rupee positions at $100 million by the close of each business day from April 10.
That marked a far tighter regime than the earlier framework under which boards could set wider exposure limits. The immediate effect was to trap banks carrying sizeable onshore-offshore arbitrage positions, many built to exploit the gap between the domestic deliverable market and the non-deliverable forward market offshore.
Estimates for those positions vary widely, from roughly $25 billion to as much as $50 billion, with market participants commonly placing the stock nearer the middle of that range. Those trades had flourished as the rupee came under sustained pressure from a mix of higher oil prices, portfolio outflows and broader geopolitical stress tied to the Iran war.
The currency slid to a record low of 94.84 per dollar on Friday before rebounding sharply once the new restrictions forced banks to sell dollars in the onshore market. That rebound, however, did not settle the market. By Monday, the rupee had surrendered much of its early gain as corporates moved in to exploit the gap opened up by the RBI action, buying dollars more cheaply onshore and selling where offshore prices remained richer.
That dislocation was striking by local standards. The spread between the onshore and non-deliverable forward markets, usually measured in a handful of paise, widened to more than one rupee before narrowing back. Even after the initial frenzy eased, the differential remained large enough to invite further trading by companies and investors able to move quickly. Traders said this meant the RBI’s intervention bought time and relief, but not a clean reset. Instead, it shifted the stress from one corner of the market to another.
Banks are now pressing for a softer landing. Several lenders have asked the central bank for about three months to comply, arguing that a forced unwind on the present timetable risks disorderly losses and could damage client relationships. Some have also proposed that existing positions be allowed to run off at maturity rather than be closed abruptly. The concern inside dealing rooms is not only the direct mark-to-market hit. Dealers also face wider bid-offer spreads, thinner liquidity and the possibility that clients caught on the wrong side of the move will demand costlier hedging solutions.
For the RBI, the logic is straightforward. The central bank has been trying to curb the influence of offshore betting on the rupee and make its own intervention in the domestic market more effective. By restricting how much exposure banks can carry onshore at day’s end, it is aiming to weaken the transmission channel through which pressure in the non-deliverable forward market spills back into the local currency market. The move also fits with a broader defence of the rupee as imported inflation risks rise with crude prices and external financing conditions tighten.
Yet the policy comes with trade-offs. A stronger official grip over dealer positions may steady the currency in the short term, but it can also make the market less flexible, reduce banks’ willingness to warehouse risk and push hedging costs higher for importers and exporters. Treasury desks that had earned from arbitrage now face the reverse. Equity investors are also watching whether weaker dealing income and higher compliance costs spill into bank earnings.
Also published on Medium.
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