Once-in-a-decade moves throw up big opportunities in forex market

At this point, it is about taking a call on how much worse can the situation get from here. The 21-day lockdown is priced in. About 2.5% getting shaved off GDP growth in Q4 is priced in. Fiscal slippage of the order of 4.5% of GDP is priced in.

In just one month, dollar-rupee volatility levels have quadrupled from 4% to 16% levels. The one-month at the money strike (ATMS) vols have been trading higher than the three-month vols, indicating panic and resulting in an inverted curve.

Significant rise in dollar-rupee volatility has led to irregular arbitrage opportunities for traders with spreads becoming highly inconsistent.

Thin liquidity in the market has led to such wide spreads, as the entire country is in a lockdown for 21 days, resulting in less participation in the currency market.

Such irregular arbitrage spreads would continue under such drastic circumstances, and till normalcy is restored. After all, it’s a battle for survival of mankind against the coronavirus epidemic.

RBI seized the opportunity amid thin liquidity to hammer the spot price lower last week. The spot was also offered on month-end exporter selling. The participation has tapered off with only flows getting covered. Amid thin liquidity, price moves have been exaggerated. The one-month NDF (non-deliverable forward) rate remains elevated at 120p. That is rubbing off on onshore exchange-traded futures as well. There is an arbitrage of approximately 45p between one-month exchange traded futures and OTC, which one can exploit.

For instance, participants could buy dollars in the OTC market on forward basis for April 28, 2020 maturity at 75.80 (spot rate 75.40 plus 40 paise premium) and sell dollars in NSE April 28, 2020 futures at 76.25, gaining 45 paise through arbitrage.

Similar opportunity has also been observed in EUR-INR. Participants can buy EUR-INR 2-month futures on the exchange and sell forward in OTC for the same maturity. There is a 90-paise spread between exchange and OTC market. OTC forward rate is 84.60 (spot rate 83.80 plus two-month forward premium 80 paise) and May NSE futures is 83.70, gaining 90 paise through arbitrage opportunity.

RBI was back shoring up its forex kitty in last six months to February, 2020, until the uncertainty about the containment of the Coronavirus emerged. From an all-time high of $487 billion, the reserves declined by $17 billion, taking it $470 billion. RBI intervened aggressively in OTC and on the exchange to ward off a speculative attack.

RBI has shown a lot of intent and has done an excellent job of managing the Rupee so far. Cash spot and near-month forwards are elevated in what is a typical financial year-end phenomenon. However, this time around, it is the higher offshore points, which are percolating into exchange and OTC, which is keeping the forwards higher.

RBI unleashed a slew of measures to complement the fiscal measures announced by the government. The measures are likely to help the banking system and economy tide over what is likely to be a protracted period of weak growth.

In an unprecedented move, RBI has permitted international units of Indian banks to participate in the NDF market from June 1, 2020. This would help reduce the transmission from offshore to onshore.