Indian firms are using arbitrage between onshore markets and non-deliverable forwards to buy dollars, putting pressure on the rupee. This activity persists despite RBI interventions to stabilize the currency. Investors should track how these corporate flows impact forex volatility and the effectiveness of central bank measures.
The Indian rupee is experiencing renewed downward pressure as domestic corporations actively engage in arbitrage strategies. This involves exploiting price differences between the onshore foreign exchange market and the non-deliverable forwards (NDF) market. By capturing these spreads, which recently fluctuated between 4 to 6 paisa for one-month contracts, companies with import and export operations are creating additional demand for U.S. dollars.
Impact on Currency Stability
This trend is complicating the Reserve Bank of India’s (RBI) efforts to maintain currency stability. Typically, the central bank intervenes in the forex market to manage volatility and prevent sharp one-way movements in the rupee. However, recent market data indicates that these interventions are facing stronger resistance due to the steady dollar demand stemming from these corporate transactions. While the rupee is often influenced by global factors like crude oil prices, this domestic arbitrage activity has become a significant localized driver of recent weakness.
Regulatory Limits on Arbitrage
To curb speculative or excessive arbitrage, the RBI introduced specific rules in late March. These regulations cap the net open position that banks can maintain on the rupee in onshore markets at $100 million. This measure forces banks to manage client exposures by executing offsetting trades in the interbank market, which effectively limits the scale of arbitrage activities and narrows the available price spreads for corporations.
Despite these restrictions, banks have become more willing to facilitate these trades for corporate clients who can provide the required underlying documentation for their import or export business. For investors, this environment means that the currency may continue to show sensitivity to these corporate flows even when external factors remain stable. The primary monitorable moving forward will be the effectiveness of the RBI's position limits and whether the central bank introduces further adjustments to manage the volume of these dollar-demand transactions.