RBI asks banks to not take new dollar positions in non-deliverable forwards

13 Oct 2022 , 12:15 PM

In an effort to stop the rupee’s decline, the Reserve Bank of India has asked local banks not to increase their positions in the non-deliverable forward market. This request, according to news reports, could cause offshore instability to spill over into local markets.

According to one of the reports, the RBI is being forced to use more reserves to protect the rupee because of the accumulation of positions in this market segment.

In contrast to the directives it gave in June 2020, which permitted banks operating from the International Financial Services Centre Banking Units to trade in the NDF segment, the RBI’s informal communication to local bankers is a step backward.

After research revealed that the NDF market, which was dominated by foreign banks and over which the RBI had little control, fuelled volatility and frequently drove the spot rupee lower in stressful situations, the central bank took action in 2020. If Indian banks were permitted to trade in the market, RBI would have more oversight.

Although the spot rupee is already under pressure, increased trading in the category has raised the demand for dollars, necessitating RBI’s intervention.

In the meantime, the rupee’s sharp depreciation in recent days had created chances for arbitrage between onshore and offshore rates. The arbitrage increases demand for dollars domestically while increasing liquidity internationally.

For instance, the 3-month forward rate is now around 25 paise higher than the corresponding onshore rate for the USD/INR NDF 1-month rate.

Approximately two weeks ago, these differences were close to 2 and 8 paise, respectively.

Eligible banks might buy spot dollars onshore and pay a 1-month premium while selling USD/INR 1-month in the NDF market to benefit from this arbitrage.

Bankers contend that the RBI’s restrictions on banks’ NDF operations won’t relieve pressure on the rupee. Instead, it would result in offshore rates once more having a greater impact on the exchange rate of the rupee.

Reuters was informed by bankers that the RBI had strictly limited activity on the NDF. It is still legal to trade forward basis points, or the distinction between two maturities.

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