Banks Unwind Billions in Arbitrage Trades Ahead of Regulatory Deadline

RBI's Directive Leads to Unwinding of Arbitrage Bets in NDF Market

The Reserve Bank of India's (RBI) directive to banks to exit their positions in the offshore non-deliverable forwards (NDF) market has led to the unwinding of most arbitrage bets ahead of the April 10 deadline, according to treasury officials. The RBI's directive was aimed at curbing speculation in the market, which had resulted in excessive volatility in the Indian rupee.

What are NDF Contracts?

A Non-Deliverable Forward (NDF) is a cash-settled, short-term forward contract on a "non-convertible" or restricted foreign currency. Unlike a standard forward contract, an NDF settles the difference between the agreed-upon exchange rate and the actual market rate at the time of maturity. This type of contract is primarily used when a currency is restricted by its home government, such as the Indian rupee.

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Quantum of Positions Wound Up

The quantum of arbitrage positions that could have been wound up is estimated to be between $30 billion and $40 billion, according to officials. This has led to a recent appreciation in the rupee, with the local currency gaining nearly 2 percent in the last seven sessions. However, the rupee halted a four-day rise to end at Rs 92.66 per dollar on Thursday.

The unwinding of arbitrage positions has been significant, with most banks exiting their positions in the NDF market. Currently, there are no open positions in the NDF market, according to a dealer in a private bank.

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Impact of Geopolitical Uncertainty

Market participants are wary of geopolitical uncertainty, which could continue to pressure the rupee. The West Asia war has led to sharp falls in the Indian currency, with the rupee tanking about 5 percent since the war broke out in late February. Record lows were breached every other session, with the rupee falling as much as Rs 95.23 per dollar on March 30, as Brent crude oil prices were trading over $100 per barrel.

RBI's Measures

In view of the sharply depreciating currency, the RBI introduced stringent measures to clamp down on heavy speculation in the offshore NDF market. The most prominent measure is the RBI's guideline that the net open position for the rupee must be within $100 million for banks at the end of each business day. The RBI had stated that these measures are temporary, as they had seen speculative positions being built in the arbitrage market in March.

Future Outlook

Even as the measures to constrain active arbitrage trading in the rupee have resulted in lesser volatility, forex dealers believe that this will be temporary, and soon the rupee's movements will be driven by global factors, such as crude oil prices and foreign inflows.