The Hindu Business Line : RBI likely to clamp down on arbitrage trade by foreign banks

Bangalore, April 21 In a bid to curb money supply expansion, the Reserve Bank of India is expected to put the squeeze on arbitrage operations by some of the foreign banks operating in the country.

Top bankers said that among the steps expected are widening of the corridor between the reverse repurchase rate of 6 per cent and the repo of 7.75 per cent. The reverse repurchase is used for removing excess liquidity from the banking system through placement of government securities with the banks. The corridor widening is expected through a hike in the repo rate or a drop in the reverse repo rate or both.

The bankers said that the RBI had already resorted to “moral suasion” on some of the banks, to discourage them from the arbitrage between the dollar and the rupee interest rate differentials. They said that some of the foreign banks were resorting to variants of the carry trade. This essentially implied raising short duration dollar funds, parking them in the reverse repo window of the RBI. Such operations resulted in spreads of about 2 per cent for them. Bankers said that such flows were one of the major factors that helped keep the rupee under Rs 40 against the dollar.

FII flows

The strengthening of the spot rupee against the dollar over the last few weeks was partly as a result of such arbitrage operations, the bankers said. Since the beginning of this current financial year, flows from foreign institutional investors into both debt and equity were on the negative zone.

According to data from the Securities Exchange Board of India, the net outflows amounted to $182 million till last weekend between April 1 and April 18. Besides, bankers said, demand for foreign currency remained high from refineries, in view of the high global oil prices. Yet this demand had little impact on the exchange rate. On Monday, the RBI fixed the reference rate at 39.89, reflecting the large inflows.

Inward remittances

The bankers said that part of the foreign currency supplies were inward remittances from exporters and invisible earnings. Foreign corporates also brought in direct investments. But considerable inflows were from arbitrage operators, they said.

Since the inflows were part of the net demand and time liabilities, the foreign banks parked the funds in the reverse repurchase window, at the LAF auctions. The parking of the funds in turn implied that the foreign banks had securities for meeting their 25 per cent SLR requirements.

Such operations also pushed up the short forward premia — cash to spot — close to 3 per cent. But bankers said that as the premia rises, the arbitrage would automatically close. The bigger fear, however, was that the flows would impact the exchange rates, and lead to liquidity expansion in the markets, fuelling inflationary expectations.

More Stories on : Foreign Banks | RBI & Other Central Banks

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page