Jaspreet Kalra and Nimesh Vora
MUMBAI (Reuters) – India’s central bank is easing restrictions on banks’ arbitrage trades between the over-the-counter foreign exchange (OTC) and non-deliverable forward (NDF) markets, four people familiar with the situation said.
The Reserve Bank of India (RBI) has allowed banks that have submitted requests to resume such transactions, a person with direct knowledge of the central bank’s thinking said. “There were banks that called and asked if they could start doing this,” and the central bank approved, the person said.
At least two state-owned banks and one private sector lender have been allowed to resume arbitration deals, three bankers said.
Arbitrage trades allow investors to benefit from differences in the prices of securities in different markets, but can exaggerate price trends.
The RBI introduced an informal ban on dollar/rupee arbitrage trades in August 2023 when it intervened to prevent the rupee from falling to a record low while banks took advantage of the price differential between the OTC and NDF markets.
Banks’ arbitrage positions had “inflated” to “double-digit billions of dollars” with which the RBI “wasn’t happy,” said a person with direct knowledge of the central bank’s thinking.
The RBI now wants to avoid a repeat and is asking banks to conduct arbitration in a manner that “does not have a negative impact on the currency,” he said.
“We sought permission from the RBI last week and they said you can go ahead,” a senior manager at a mid-sized public sector bank said on Monday. The bank has not yet begun to build its currency arbitrage portfolio.
All individuals declined to be named because they were not authorized to speak to the media.
The RBI did not immediately respond to an email seeking comment.
The removal of NDF arbitrage restrictions comes at a time when the Indian rupee is going through a period of calm.
The currency’s 30-day realized volatility has been below 2% since October, and volatility expectations are lower than those of Asian peers. Low volatility means that over-the-counter rupee and NDF rates diverge infrequently and marginally, resulting in reduced arbitrage opportunities.
The RBI has allowed arbitrage trades “but in a limited and slow manner,” said a trader at a second public sector bank.
“There is virtually no arbitration at the moment, so activity on our end has been slow.”