Earlier in the month, the Reserve Bank of India had put some restrictions on financial tools to stop the rupee from losing value too quickly. Now, the central bank has cancelled two of these rules while keeping others in place, and are doing this to keep the market working as it should, while also keeping speculative trades under control.
Overview of the eased measures
Banks and financial institutions that are authorised to do so can now provide non-deliverable forwards (NDFs) with the rupee to people and businesses both in India and abroad. This reverses a recent rule that had limited these offers, because they were increasing the amount of risky, speculative trading of the currency from outside the country.
The RBI has also removed the rule preventing cancelled foreign exchange derivative contracts from being rebooked after April 1st. This allows people in the market to be more flexible with how they manage their risks, and to start hedging their money again if they had to end those hedges because of the temporary rules.
Restrictions that remain in force
However, banks are still not allowed to make rupee-based derivative contracts with companies and people that are related to them. This is to prevent ‘circular’ trades and moving risk within a company group, which would hide what the market is really doing.
The central bank has made a few very limited exceptions to this. Dealers can cancel or extend existing contracts with related companies and do “back-to-back” deals with unrelated customers overseas. Banks are also still limited to a net open position of $100 million in the rupee market, at the end of the day.
Recent market drivers and RBI actions
These original restrictions were brought in after the rupee had lost a lot of value quite quickly, and there was a lot of risky betting on the currency in the offshore NDF market. Higher oil prices and growing problems in the Middle East increased the demand for US dollars and caused more market fluctuations in late March and early April.
By April 10th, banks had closed nearly $40 billion of these speculative NDF positions, and that helped the rupee to recover from its lowest point ever, around 95.21 to the dollar. The central bank said the rules were just a short-term fix for a specific problem in the market, not permanent changes.
Market reaction and implications for banks and dealers
Allowing NDFs again should put some more money into offshore hedging locations and give companies and investment managers more ways to deal with the risk of the rupee’s value changing. Dealers can once again design contracts for a wider variety of customers, and this could lessen the difference in prices between the rupee market in India and the rupee market overseas.
The $100 million limit on a bank’s net open position will force banks to be careful about how much they are trading in the rupee market both during the day and on their balance sheets. Risk management teams will have to check their positions in India and overseas and make sure they follow the rules about related-party transactions and the limited exceptions.
Outlook and policy intent going forward
The central bank has indicated that the restrictions weren’t meant to last forever and this partial removal of the rules shows that. The RBI also says it is still fully committed to developing and making larger markets international, whilst protecting against too much fluctuation.
In the future, the rupee’s value will continue to be affected by what’s happening in the world, oil prices and how much demand there is for the dollar. The RBI seems willing to use whatever tools are necessary to limit risky behaviour and keep the market working properly.
