India’s forex reserves, at $700.9 billion, though lower than their late-February peak, are adequate. Selling dollars to arrest currency depreciation cannot be a never-ending process
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Reserve Bank of India
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> Banks unwind 75 per cent of forex arbitrage bets in the last four trading sessions. Bankers estimate around $30 billion worth of open positions have been squared off, of $40 billion bets against the rupee. – April 7
> Of the $40-odd billion in aggregate positions, only about $4-7 billion is estimated to have remained at the end of trading on Thursday. – April 9
This is how the media covered banks’ response to the Reserve Bank of India’s (RBI’s) recent measures to curb rupee depreciation.
Before examining these steps, it is useful to understand arbitrage trades. The RBI used to allow banks to participate in non-deliverable forward (NDF) markets, with offshore positions netted against onshore ones to determine net risk. When the rupee is expected to weaken, NDF rates tend to be higher than onshore rates. Banks benefit from it by selling dollars in offshore NDF markets and buying them onshore, locking in the spread.
Offshore demand in NDF markets is met by banks selling non-deliverable forwards and covering them domestically. As demand for dollars surged, arbitrage volumes rose sharply, pushing total arbitrage positions to nearly $40 billion. Without these trades, offshore dollar-rupee rates at NDF markets may have risen further, potentially impacting onshore levels as well.
That said, speculative elements in these trades cannot be ruled out. The RBI’s recent measures have significantly curtailed such activity.
What are those measures?
On March 27, the RBI capped banks’ net open position (NOP) in the onshore rupee market at $100 million and disallowed netting with offshore NDF positions from April 10, citing “market conditions”. Earlier, banks could net the two, with the combined position capped at $100 million. NOP is the difference between a bank’s foreign currency assets and liabilities, revealing its exposure to currency fluctuations or exchange rate risk.
This is not the first time the RBI has done this. In December 2011, it slashed NOP limits by up to 75 per cent for some banks and 50 per cent for larger ones after the rupee weakened sharply.
Since 2013, bank boards have been allowed to set NOP limits within a cap of 25 per cent of their Tier-I and Tier-II capital, though the RBI has maintained a “soft limit” of $100 million, retaining the discretion to tighten it during volatility. Tier-I is a bank’s networth and Tier-II is subordinated debt, revaluation reserves and a few other hybrid capital instruments.
In January this year, the RBI proposed changes to how banks calculate their foreign exchange exposure and the capital needed to be set aside against potential risk. The aim is to align them with global standards across regulated entities. The RBI has sought feedback to the rules, which are expected to be in effect from April 2027.
The March 27 directive had limited immediate impact, as banks running arbitrage positions likely shifted exposures via deals with some corporations and related overseas entities. So, on April 1, the RBI barred banks from offering NDF contracts to both resident and non-resident clients.
Authorised dealers (banks permitted to buy and sell foreign exchange) were prohibited from offering non-deliverable rupee derivatives, though deliverable contracts for genuine hedging were permitted. Banks were required to ensure that clients did not hold offsetting offshore positions.
The RBI also barred the rebooking of forex derivative contracts involving the rupee that was cancelled after April 1. Finally, banks were told not to undertake any such contract involving the Indian unit with their related parties.
Indian banks were first allowed into the NDF market in June 2020 to better integrate onshore and offshore currency markets, improve price discovery, and reduce volatility. In June 2023, the RBI expanded this access to allow banks to offer NDF contracts to non-retail residents for hedging.
The RBI has since periodically intervened informally to check rupee volatility. In June 2022, for instance, it asked banks not to build additional NDF positions since this was forcing it to spend more reserves to defend the rupee (Reuters report quoting a banker).
In August 2023, it again informally restricted dollar-rupee arbitrage trades as part of measures to prevent the rupee from slipping to a record low. It eased these curbs in April 2024.
The latest measures follow a sharp depreciation in the rupee, which weakened by at least 4 per cent against the dollar in March as the West Asia war intensified. In FY26, the rupee has declined nearly 10 per cent (the most since FY12), making it the worst-performing Asian currency this year.
At the annual forex dealers’ conference in Paris on March 11, RBI Deputy Governor T Rabi Sankar, who oversees, among other things, currency management, forex, external investments and operations, blamed arbitrage between offshore and onshore markets for draining on dollar liquidity when the rupee was under pressure because of large foreign outflows.
A Bloomberg report suggests Sankar spoke about RBI’s displeasure over banks transferring arbitrage trades to corporate clients, even though companies are not permitted to undertake such transactions.
An April 16 Reuters report says the RBI has asked state-run oil refiners to limit spot dollar purchases and instead use a special credit line for forex needs.
How did the rupee react to these measures?
On March 27, it opened at 94.1550 per dollar, fell to 94.8450, and closed at 94.8150. By March 30, it had opened at 93.4775, touched a low of 95.125 before closing at 94.8325.
After the second measure, on April 2, it opened at 93.25 and closed at 93.105, after hitting a high of 92.82. It even touched 92.41 a dollar, its highest in the recent phase.
Following the credit line announcement for oil refiners, the rupee appreciated further to 92.66 before closing at 92.92 on Friday.
The RBI has emphasised that the new norms will not affect genuine hedging activity. Even so, tighter restrictions will definitely push hedging costs up. This could deter foreign capital flows into both equity and bond. Since October 2024, foreign investors have pulled out at least $45 billion. Their shareholding in Indian equities is currently at a 15-year low.
The April monetary policy statement flagged upside risks to the current account deficit, particularly from rising crude prices, which could fuel imported inflation.
RBI Governor Sanjay Malhotra has described the recent curbs on the NDDC (non-deliverable derivative contract) market and banks’ NOP as temporary. In his post-policy media interaction, he emphasised that the measures aimed to address specific, excessive currency volatility and were “not going to remain there forever”.
In fighting currency depreciation, the RBI is broadly following past playbooks. However, it is yet to consider actions such as a rate hike or mobilising dollar inflows from non-resident Indians through instruments such as the India Millennium Deposit (2000) or Foreign Currency Non-Resident (Bank) [FCNR(B)] deposits (2013) to boost forex reserves.
The twin steps could be interpreted as desperate measures in desperate times, but the RBI cannot afford to continue with them for long when the rupee’s internationalisation tops its agenda. India’s forex reserves, at $700.9 billion, though lower than their late-February peak, are adequate. Selling dollars to arrest currency depreciation cannot be a never-ending process.
The RBI’s forward book stood at $77.7 billion as of February, the highest since March 2025, and is believed to have risen further in March. This affects the regulator’s ability to use buy-sell swaps to sterilise its spot dollar selling.
The forward book represents the net outstanding contracts the RBI has entered into through buy-sell swap or dollar sales at future dates. A “negative” or “short” forward book means the RBI has sold dollars forward to stabilise the rupee without immediately depleting forex reserves. But that’s a different story.
The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, log on to http://www.bankerstrust.in.
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