Stung by the rupee’s recent collapse, Reserve Bank of India (RBI) is taking a carrot-and-stick approach to curb trade in the offshore forwards market that is seen as a key source of wrenching currency volatility.
The Reserve bank met with local banks asking them to stop acting as market makers for the INR in non deliverable forwards. Bearish bets on the rupee in offshore markets have been cited by traders as a key cause of the rupee’s recent harrowing plunge, when it slumped to a series of record lows, losing as much as 20 percent in 2013 to 68.85 to a dollar in late August .Given the sparse alternatives to other options however the strategy is thought to have limited impact.In an effort to add more gravitas the central bank has held out the promise of easing restrictions to allow greater participation in the onshore foreign exchange market by overseas participants.The presence of a two tier market ie onshore and offshore again can only be attributed to India’s sloth like progress towards full capital account convertibility. Faced with slowing economic growth and a yawning current account deficit the NDFs market has been an ideal vehicle that traders have utilized to bet against the rupee. The offshore market in the partially convertible rupee has flourished, with average daily trading volumes rising to about $5 billion a day earlier this year from a few hundred million dollars in 2006, traders say. That puts the offshore trade on par with India’s restrictive onshore market, where daily spot volumes are around $5-$6 billion.
The problem is markets have been here before on India and memories are long. Global funds cannot re-book a forward contract onshore once cancelled, and foreigners are not allowed to trade in local currency futures despite a promise in February to let them in. New RBI chief Raghuram Rajan, who took office Sept 4, said the bank will look to ease restrictions once the rupee stabilizes. Given the rupees nascent recovery since the depths of the crisis it seems that the market will continue to bet against the rupee till concrete steps are taken by a central bank governor who is still finding his feet and the implementation of reforms by the government that seems strangely mute.
In one of many efforts to crack down on such arbitrage, the RBI in July imposed higher margin limits for banks trading in the onshore exchange-traded currency futures market. Offshore rupee volumes have fallen by roughly half since then, some traders said, while the rupee has also stabilized somewhat. Volumes in other emerging market NDFs have also fallen amid recent emerging market weakness during the depths of the rupee’s weakness, the 1-month NDFs was an unusually wide 2.5 percent weaker than the onshore spot rate, as overseas investors bet heavily against the currency.