01/04/2026
India’s money market is set to face its biggest shock in years, with the situation expected to worsen as major banks prepare to close down billions of dollars worth of arbitrage trades, triggering a chain reaction in the currency market.
The Reserve Bank of India (RBI) issued new rules on Friday evening to curb bearish positions on the rupee. The move sparked an immediate backlash from the banking sector. Bankers on one hand urgently called on the central bank to reconsider the policy, while on the other, fielded a flood of anxious customer inquiries and stepped up efforts to devise plans to limit trading losses, which are estimated to reach at least $30 billion.
When trading resumed on Monday, traders witnessed a market gripped by panic and extreme illiquidity. One trader described the pressure to complete transactions as being like a trainee doctor performing heart surgery. While precise trade data is hard to come by, people familiar with the matter estimated that banks have already closed arbitrage positions under the central bank’s scrutiny in the range of $4 billion to $10 billion.
This means that unless the central bank reverses course, the vast majority of remaining positions must be closed by the April 10 deadline set by the RBI. Despite this, even as the central bank signaled no intention of changing its stance, some banks chose to adopt a wait-and-see approach on Monday. Additionally, India’s foreign exchange market was closed for holidays on Tuesday and Wednesday, leaving only Thursday as a full trading day.
Ashish Vaidya, Mumbai-based head of markets at DBS Bank, said: “Based on client positioning data and fund flows in the non-deliverable forward (NDF) market, approximately 25% to 30% of total positions were closed on Monday alone. This indicates that the foreign exchange market will experience new volatility once trading resumes.”
The RBI’s regulatory move is one of the strongest attempts in over a decade to curb currency speculation in India. The rupee, which initially edged higher, quickly reversed course and plummeted to new lows, highlighting deeper pressures—from surging crude oil prices to sustained capital outflows and a widening trade deficit.
India is particularly vulnerable to the Iran conflict and soaring energy costs due to its heavy reliance on imports. On Monday, the rupee closed near 94.80 against the US dollar, with the intraday range marking its largest gap since 2013.
The directive triggered a rush by banks to unwind arbitrage trades, which typically involve buying dollars in the onshore market and selling them offshore for profit. As these positions were reversed, the spread between onshore and offshore forward exchange rates spiked to its highest level since 2020.
Industry participants expect trading volume in the foreign exchange market to remain subdued in the short term. Major banks have jointly submitted applications to the RBI, requesting an extension of the closing deadline. If the central bank fails to make concessions by April 6, subsequent volatility in the rupee exchange rate will intensify. Currently, multiple banks are continuing to push for relaxed regulatory restrictions.
This week, the overnight implied volatility of the USD/INR pair soared to its highest level since November 2020, indicating that traders are fully prepared for significant currency fluctuations. Traders and bankers interviewed by Bloomberg News requested anonymity as they were not authorized to speak publicly on the matter.
Following the RBI’s policy announcement, funding departments at various financial institutions held intensive conference calls over the weekend to urgently formulate response plans, which directly led to sharp volatility in the foreign exchange market on Monday morning. Many institutions received a large number of inquiries from overseas investors regarding the disposal of their positions. An employee at a foreign bank revealed that they spent almost the entire day on the phone with clients on Saturday, far longer than usual.
By Monday morning, most banks had recognized the need to reduce their foreign exchange risk exposure. Trading floors, which are usually busy just before the market opens, had staff on duty before dawn, with each bank racing against time to assess risks and formulate exit strategies for their positions.
A trader revealed that their institution started reducing positions as early as 8 a.m. Mumbai time, one hour before the official market opening, due to a noticeable divergence between offshore non-deliverable forward contracts and the domestic Indian market. Within the first hour of trading, the bank had reduced a considerable amount of relevant positions.
However, another trader stated that on Monday, most state-owned banks chose not to close their positions to cut losses, mainly fearing that this would impact their financial books on the last trading day of the financial year. Such hesitation is also a key reason why the rupee erased all its early gains after rising initially.
Some financial institutions opted to delay action, hoping that market conditions will stabilize or that regulators will show flexibility. Some banks are also exploring alternative options, such as transferring relevant positions to other entities within the group.
India has previously imposed restrictions on foreign exchange positions, such as in 2011, but market participants generally say the latest regulations are far more stringent. Over the past decade, the scale of foreign exchange trading in India has expanded significantly. Previous policies focused on overall positions and allowed banks to net positions across onshore and offshore markets. In contrast, the new rules specifically target the onshore foreign exchange market, forcing banks to close their positions at a significant cost.
The central bank’s move also reflects widespread market concerns about the role of the offshore market in driving up the depreciation pressure on the rupee. Sustained demand for US dollar hedging and speculative positions has pushed up offshore forward points—the additional cost of locking in future USD/INR exchange rates—creating a vicious cycle of further bets on rupee depreciation.
Previously, Indian authorities had attempted to stabilize the currency through direct market intervention, but this came at the cost of a significant decline in foreign exchange reserves.
Analysts at Barclays said on Monday that while the initial impact of the RBI’s new policy may fade, the central bank may still introduce further measures to defend the rupee, including tighter restrictions on bank foreign exchange positions, stricter oversight of the non-deliverable forward market, and measures to manage dollar demand and encourage capital inflows.
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