A familiar drag on the Indian
currency has resurfaced with local companies exploiting the
arbitrage opportunities between the onshore foreign exchange
market and non-deliverable forwards, spurring additional dollar
demand that ispressuring the currency, four bankers said.
The rupee fell to 95.4725 per US dollar on
Monday, after sliding 0.86 per cent through last Friday, its worst
weekly performance in nearly two months.
The currency’s drop beyond the 95-per-dollar mark came
despite Brent crude prices holding at pre Iran-war levels of
about $70 a barrel and intervention by the Reserve Bank of India
supporting the currency.
While a broad dollar rally and routine importer demand for
dollars have contributed to the rupee’s weakness, the currency’s
decline has been fuelled further by the return of arbitrage
opportunities between the NDF and the onshore market, bankers
said.
Corporate clients with both import and export exposures and
the underlying trade documentation required to execute such
transactions have been actively exploiting the price
differential, the bankers said.
“Clients are jumping on the arbitrage opportunity. It’s free
money,” said an FX salesperson at a foreign bank, requesting
anonymity along with other bankers Reuters spoke to for the
story, since they are not authorised to speak to the media. The
salesperson said his desk had executed around 10 such
transactions in recent days.
The impact of these arbitrage flows was most evident on
Thursday and, to a lesser extent, on Friday, when the one-month
dollar/rupee contract in the NDF market traded 4 to 6 paisa
above the equivalent onshore rate. The spread remained largely
intact on Monday.
The arbitrage flows contributed to the rupee weakening last
Thursday despite pre-market RBI intervention that initially
lifted the currency. Such intervention has typically been
sufficient to disrupt one-way bearish positioning against the
rupee. On Thursday, however, the support proved short-lived.
LIMITED TRADE SIZES
To limit the pressure from arbitrage trading activity, the
central bank in late March limited the net open position banks
could hold on the rupee in onshore markets to $100 million.
To stay within this cap, banks undertake countervailing
trades in the interbank market, offsetting client-related
onshore exposures, bankers said.
The requirement to execute back-to-back transactions limits
the size of arbitrage trades banks can facilitate, the bankers
said. Additionally, such transactions consume limits that
corporates have with banks, keeping position sizes relatively
modest, according to the FX salesperson cited previously.
Both of these have led to the size of such arbitrage trades
remaining well below the size of positions that banks had built
up before the central bank’s restrictions came into effect.
That effectively limits the size of arbitrage trades banks
can facilitate and narrows the spreads that corporates are able
to capture, they said.
Banks initially were “extremely cautious” about facilitating
NDF-related transactions for clients, said a treasury official
at a foreign bank.
“Now, as long as clients can provide the necessary
underlying documentation, banks are a lot more comfortable.”