How RBI Managed to Curb the Rupee Fall Through NDF Measures

The Indian rupee made headlines twice this week. First for all the wrong reasons, touching record lows and raising fears of a slide toward 100 to the dollar after touching the all time high of little over 95. Then, just as quickly, it staged one of its sharpest single-day recoveries in over a decade.

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What Happened on April 2

The Indian rupee surged 1.8%, to settle at 93.10 against the US dollar. It had closed at 94.83 in the previous session. This marks the biggest single day gain for rupee in nearly 12 years, when the US Federal Reserve first signalled it would reduce its bond-buying programme and triggered sharp currency moves across emerging markets. The rupee also emerged as the best-performing Asian currency on the day.

What Triggered the Recovery in Rupee

This move was not triggered by any peace settlement in the Middle East, decline in crude oil price, or anything else positive in terms of the international macro scenario. On the contrary, the price of oil was actually increasing by around 7-8% on the very same day. It was solely due to the move taken by the Reserve Bank of India.

There were two particular moves made by the Reserve Bank of India. One, it stopped banks from issuing Non Deliverable Forwards contracts, which is also known as NDF contracts. Two, it placed restrictions on the rebooking of foreign exchange derivatives after cancellation by RBI's orders.

Understanding the NDF Market

NDF contracts are currency derivatives traded outside India, mainly in financial centres like Singapore and Dubai. Unlike regular forward contracts, they do not involve actual delivery of currency. Instead, they are settled in dollars based on the difference between the agreed rate and the spot rate at maturity.

These contracts are widely used by foreign investors and traders to take positions on the rupee without participating in the domestic market.

The problem arises when there is a disconnect between offshore NDF rates and onshore forward rates. This creates arbitrage opportunities for banks and traders.

RBI Interventions

Moreover, the RBI put conditions regarding the rebooking of foreign exchange derivative contracts. In the former case, there was the liberty to cancel a position and book another one according to one’s whims, whereas the derivative instruments were used for speculating purposes. As a result of new rules, the only function to perform will be the management of risks, not speculation.

At the same time, the regulator introduced a new rule to increase the amount of the Net Open Position of the banks. From April 10, it is necessary for the banks to keep exposure in the currency market both within and outside the borders at the level of $100 million. Hence, there will be no possibility to bet against the rupee anymore, and the building up of the arbitrage positions will be restrained.

In addition, the RBI directly intervened in the foreign exchange market, offering dollars through state-owned banks in order to provide immediate assistance to the rupee market in these times of increased volatility. Overall, these actions led to the incentives for traders to take advantage of their profits, thus selling off their positions and creating demand for the rupee. Therefore, it helped the recovery of the rupee exchange rate and decreased possibilities for future speculations in this sphere.

The Arbitrage Trade That Was Killing the Rupee

In the days before the RBI's intervention, a large-scale arbitrage trade had built up across Indian and offshore currency markets. Banks were taking long positions on the dollar in the offshore NDF market while simultaneously taking short positions in the local forward market. This two-sided trade was creating artificial pressure on the spot rupee, pushing it weaker than where fundamentals alone would have taken it.

Illustration:

If the dollar is trading at ₹92 in India but ₹94 in the offshore market, a bank can buy dollars offshore and sell them locally to profit from the price gap. When many players do this together, it increases demand for dollars and puts pressure on the rupee, even without any real economic reason.

Is This Recovery Sustainable?

The initial bounce was primarily a case of market correction, where unwinding of positions and decline in speculation was seen. The tighter norms for net open position management by the Reserve Bank of India along with restrictions in off-shore trading would ensure that the build-up of such stress through arbitrage would be much harder going forward. In other words, there is a structural change in how the markets work.

However, the Indian rupee still faces a lot of external pressures. Crude oil continues to be the key determinant. About 85%–88% of India’s oil requirements are met through imports, and once the price rises above $110 per barrel, the total cost of imports increases significantly, resulting in increased demand for dollars in the foreign exchange market. The volatility in West Asia, particularly the risk concerning the Strait of Hormuz, adds another dimension of supply risk, which is difficult to predict beforehand. The future course of the Indian rupee depends on crude oil prices, geopolitical risks, global interest rate levels, and international capital flows into/out of India.

Conclusion

The rupee’s recovery is real, but its durability depends on factors beyond the RBI’s control. The central bank has acted decisively to curb speculative activity and stabilise the market. The structural fixes through new NOP (Net Open Position) regulations are likely to reduce volatility and prevent a repeat of the recent episode.

For equity markets, a stabilising rupee is a meaningful positive. It reduces imported inflation, takes pressure off corporate margins for import-dependent businesses, and improves the attractiveness of Indian assets for foreign investors.
However, the next phase will depend largely on global developments, particularly oil prices and geopolitical stability.