India's Trading Ban Disrupts $149 Billion Daily Offshore Rupee Market

India Cracks Down on Rupee Trading in Bid to Stabilize Currency

The Reserve Bank of India (RBI) has implemented some of its toughest measures in over a decade to curb speculation and support the rupee, which has been setting successive record lows this year. The RBI has banned its banks from offering the most popular instrument for trading the rupee offshore, a move that threatens to squeeze a $149 billion-a-day market.

The RBI's decision is part of a coordinated push to flush out excess bearish rupee positions and speculative trades across the market. To achieve this, regulators capped lenders' daily onshore currency positions at $100 million, a move that sent banks scrambling to unwind at least $30 billion in arbitrage trades. When this failed to stop the rupee from hitting a new low, the RBI prohibited banks from offering certain non-deliverable derivative contracts.

The rupee surged the most in 12 years on Thursday as currency trading resumed after a two-day break. It gained almost 2% to 93.25 per dollar, having traded at an all-time low above the 95-per dollar level earlier in the week. This comes as the pressure on the rupee has intensified since the Iran war accelerated the rupee's decline.

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The RBI's measures amount to a significant departure from its previous stance on currency markets. The RBI has been pushing to deepen India's currency markets and improve price discovery, aligning with Prime Minister Narendra Modi's broader push to boost the rupee's global use. However, the risk is that such moves may undercut years of efforts to deepen India's currency markets and improve price discovery.

Comparison of Onshore and Offshore Rupee Markets

The RBI's measures may deter participation, increase costs, and ultimately make it harder for businesses and investors to hedge currency risk. Liquidity across both onshore and offshore markets has expanded in recent years, a key factor in attracting foreign investors. However, the RBI's focus is on the stability of the rupee rather than liquidity, according to Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership.

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Kunal Sodhani, head of treasury at Shinhan Bank Ltd. in Mumbai, has stated that the RBI's measures may come at the cost of reduced liquidity and wider spreads between the onshore and offshore markets. The RBI's message is unambiguous, he said, with the FX market expected to function as a hedging mechanism aligned with real economic activity, not as a platform for leveraged speculation.