Decoding RBI’s move to curtail rupee speculation

UPSC Syllabus: Gs Paper 3- Indian economy

Introduction

The Reserve Bank of India has capped banks’ foreign exchange exposure to contain rising pressure on the rupee. The currency weakened due to global risk aversion linked to the Iran conflict and strong demand for the US dollar. Banks were actively using arbitrage between onshore and offshore markets. By limiting Net Open Position in Indian Rupee (NOP-INR), the measure aims to curb speculative positions and support the rupee in the short

Understanding NOP-INR and Forex Exposure

1. Meaning of NOP-INR (Net Open Position in Indian Rupee): It shows the total foreign exchange exposure of banks, measured as the difference between their foreign currency buying (long) and selling (short) positions, mainly in US dollars against the rupee.
2. How it is calculated: It includes positions from spot transactions, forward contracts, and swaps in the over-the-counter market, along with Exchange-Traded Currency Derivatives like futures and options.
3. Why derivatives are included: Even though these derivatives are cash-settled and do not involve actual delivery, they still add to overall exchange rate risk.
4. Importance in risk management: NOP-INR gives a complete picture of a bank’s exposure to currency movements, helping measure the risk arising from changes in the rupee’s value.

RBI’s Directive: Key Features

1. Cap on Net Open Position in INR (NOP-INR): Banks must keep their Net Open Position in Indian Rupee (NOP-INR) within $100 million in the onshore deliverable market at the end of each business day.
2. Timeline for compliance: All banks were given time until April 10, 2026 to bring their positions within the prescribed limit.
3. Focus on onshore deliverable market: The rule applies to transactions within India that involve actual exchange of currency, such as spot, forward, and swap deals.
4. Role of Exchange-Traded Currency Derivatives (ETCDs): Exchange-Traded Currency Derivatives (ETCDs) like futures and options are included in NOP calculation, but the main focus is on controlling exposure in deliverable transactions.
5. Indirect impact on offshore market: The directive does not directly mention offshore markets, but by limiting domestic exposure, it is expected to reduce arbitrage activities between domestic and offshore markets.

Rationale Behind RBI’s Move: Role of Arbitrage and Market Dynamics

1. Pressure on rupee due to global factors: The rupee weakened because of global risk aversion linked to the Iran conflict, which increased demand for the US dollar as a safe asset.
2. Build-up of long-dollar positions: Banks created large long positions in US dollars, meaning they bought more dollars expecting further rise, which increased pressure on the rupee.
3. Arbitrage strategy explained: Banks used arbitrage, meaning they earned profit from price differences by buying dollars in the onshore market and selling them in offshore markets.
4. Onshore vs offshore markets clarified: The onshore market includes domestic transactions with actual delivery of currency, while the offshore market uses Non-Deliverable Forwards (NDF), which are contracts settled in US dollars without actual exchange of rupees.
5. Link between both markets: Although onshore and offshore markets are separate, they are closely linked through arbitrage. Banks operate in both markets to exploit price differences. This linkage allows movements in one market to influence the other and increases overall speculative pressure on the rupee.
6. Policy objective of RBI: By limiting Net Open Position in Indian Rupee (NOP-INR), the Reserve Bank of India aims to reduce arbitrage trades, force banks to unwind dollar positions, and support the rupee by increasing dollar supply in the market.

Impact Assessment

1. Immediate market reaction: The rupee initially improved but later weakened again, touching a fresh all-time low of 95.23, showing strong underlying pressure.
2. Effect on domestic speculation: The cap is likely to reduce speculative activity in the domestic market, as banks face limits on exposure.
3. Limited control over offshore markets: Offshore NDF markets may continue speculation due to global participation and lack of direct regulation.
4. Influence through indirect channels: RBI can affect offshore markets indirectly through domestic actions and participation of Indian banks, improving price alignment.
5. Constraints from global factors: Factors like capital outflows, high crude oil prices above $100, and widening trade deficit can keep pressure on the rupee.
6. Nature of the measure: The cap is a short-term or tactical step, which may prevent further sharp depreciation but does not solve structural issues affecting the currency.

Conclusion

The Net Open Position in Indian Rupee (NOP-INR) cap can reduce speculative activity and limit arbitrage-driven pressure in the short term. However, it does not address key drivers like capital flows, interest rate differences, crude oil prices, and trade imbalance. Sustained stability of the rupee requires favourable global conditions and improvement in these underlying economic factors.

Question for practice:

Examine how the Reserve Bank of India’s cap on Net Open Position in Indian Rupee (NOP-INR) aims to curb arbitrage-driven speculation and stabilise the rupee.

Source: Businessline