India’s central bank, the Reserve Bank of India (RBI), is reportedly easing restrictions on banks’ arbitrage trades involving the outright foreign exchange over-the-counter (OTC) and the non-deliverable forward (NDF) markets. According to sources, the RBI has granted approval to banks, upon request, to resume such trades. At least two public-sector banks and one private-sector lender have been given the green light to restart arbitrage trades.
The move comes after an informal ban was imposed by the RBI in August 2023 on dollar/rupee arbitrage trades. During that time, the central bank intervened to prevent the rupee from reaching a record low, and banks were taking advantage of price differences between the OTC and NDF markets. The RBI was reportedly unhappy with the significant size of banks’ arbitrage positions, which had reached “double-digit billions of dollars.”
The RBI’s current approach aims to prevent a repeat of the earlier situation and emphasizes that arbitrage should not adversely impact the currency. While the central bank has permitted the resumption of arbitrage trades, it is reportedly urging banks to proceed cautiously.
The lifting of NDF arbitrage restrictions comes at a time when the Indian rupee is experiencing a period of low volatility. The 30-day realized volatility of the currency has been below 2% since October, and volatility expectations are lower compared to other Asian peers. The decreased volatility has led to fewer arbitrage opportunities, as the rupee’s OTC and NDF rates rarely diverge significantly.
It’s worth noting that while the RBI has given approval for arbitrage trades, the activity has been described as limited and slow due to the current lack of substantial arbitrage opportunities in the market.