The Reserve Bank of India’s restrictions on non-deliverable derivative contracts are set to ripple through major currency hubs such as Singapore and London, where trading volumes have expanded over the past decade to roughly twice the size of the onshore market. The rupee surged the most in 12 years on Thursday.
The policy follows a late-Friday measure that capped lenders’ daily currency positions at $100 million, triggering a scramble among banks to unwind at least $30 billion in arbitrage trades. Such moves risk undermining years of efforts to deepen India’s currency markets, where growing liquidity has helped attract foreign investors and support Prime Minister Narendra Modi’s push to expand the rupee’s global use.
“This is again a signal that the central bank is willing to consider harsh steps that are nevertheless regressive and that its focus is on the stability of the rupee rather than liquidity for now,” said Abhishek Upadhyay, economist at ICICI Securities Primary Dealership.
The regulator is targeting a trade it sees as fuelling speculative bets. Investors have typically used offshore contracts, known as non-deliverable forwards, to build short rupee positions, while banks have run arbitrage trades — buying dollars onshore and selling them overseas — to profit from price gaps. These onshore dollar purchases can add pressure on the local currency, reinforcing bearish offshore bets.
This activity is largely driven from global financial hubs such as Singapore, London and New York, with international lenders including JPMorgan Chase, Standard Chartered, HSBC and Citigroup dominating the space. Some Indian banks also participate.
The RBI’s measures amount to a coordinated push to flush out excess bearish rupee positions and speculative trades, according to Kunal Sodhani, head of treasury at Shinhan Bank in Mumbai. This may come at the cost of reduced liquidity and wider spreads between onshore and offshore markets, he said.
“Overall, the RBI’s message is unambiguous,” he said. “The FX market is to function as a hedging mechanism aligned with real economic activity, not as a platform for leveraged speculation.”
The rupee has been hitting successive lows despite repeated intervention by the RBI, with pressure intensifying after the Iran war pushed up India’s fuel import costs. It has declined about 8% over the past year, making it Asia’s worst-performing currency.
The rupee rebounded about 2% to 92.84 per dollar on Thursday as trading resumed after a two-day break. Earlier in the week, it had weakened past the 95 level. Meanwhile, offshore forward points — the cost of hedging exposure to rupee assets outside India — are near their highest levels since 2020.
The twin policy measures are aimed at containing imported inflation by supporting the currency. Elevated energy prices have stoked stagflation concerns, with oil importers such as India particularly vulnerable. A widening trade deficit, coupled with a stronger dollar, has added to pressure on the rupee.
Also Read: Oil to drive rupee after April 10 as RBI impact fades: Kotak Securities
This leaves the RBI in a difficult position. Raising interest rates to defend the currency could weigh on economic growth, prompting policymakers to rely more on alternative tools. These include stepped-up intervention — which has already contributed to a more than $30 billion drawdown in foreign exchange reserves in the first three weeks of March — as well as direct measures targeting financial institutions. The central bank is scheduled to announce its next rate decision on April 8.
“The RBI cannot use monetary policy to fight this pressure as they are primarily focused on inflation management,” said Gaurav Kapur, chief economist at IndusInd Bank. This helps explain the move to target the NDF market, he said, adding that the central bank still has other options, including a potential increase in the cash reserve ratio, as seen in 2013.
Bond outflows
By curbing NDF activity, the central bank is increasing the cost of hedging currency risk, said Rajeev de Mello, global macro portfolio manager at Gama Asset Management. This could discourage foreign participation in the local bond market and push up the government’s borrowing costs.
Foreign interest in Indian debt has grown, with about $14 billion flowing into bonds since their inclusion in JPMorgan’s flagship index in June 2024, underscoring the need for hedging. However, flows have been hit by the latest curbs. On Monday, index-eligible bonds saw outflows of ₹32.85 billion ($352 million), the largest single-day exit in 10 months.
A key question now is how long the RBI can sustain such measures. When similar steps were taken in December 2011, the rupee strengthened from 54.3 to below 50 within about a month — but at the cost of liquidity drying up, said Madhavi Arora, chief economist at Emkay Global Financial Services.
“If a similar playbook is followed this time as well, the rupee could be a sharp gainer over the next week or so, as banks unwind speculative positions,” she said. While lenders may face short-term mark-to-market losses, the focus could shift back to credit growth once the currency stabilises and liquidity conditions normalise.
This time, however, the impact could be more disruptive given the scale of foreign exchange operations.
Also Read: RBI curbs speculation, rupee still seen weak: ANZ Research
“Ten years ago, people didn’t take such large positions,” said Jayesh Mehta, chief executive officer of DSP Finance. Today, the size of trades — including relative-value bets across currencies — may dilute the effectiveness of the RBI’s interventions, he added.
