They are understood to have passed off some of the arbitrage deals, which were hit by the recent regulatory directives, as transactions done to hedge the capital received from overseas parents, two persons told ET.

Arbitrage deals are cut to profit from price differences in the local foreign exchange forward market and the offshore market for non-deliverable forwards (NDFs).

Banks were forced to unwind these deals after the Indian regulator slapped a uniform limit of $100 mn on the net open position (NOP) a
bank can have onshore.

However, some MNC banks are showing the capital that has come in earlier or flowed in recently from their head-offices as underliers for the onshore forward leg in the arbitrage deals. Thus, this buy-dollar forward contract with a proper underlier is shown as a transaction to cover the risk arising from a slide in the rupee – and not as any part of an arbitrage deal.

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Foreign banks function as branches in India which are part of the global books. The capital coming in as dollars or euros into an MNC bank’s India operations, are converted into rupees to support and grow the business here.
“Technically, this may be a response to the NOP limit. But whether this explanation would stand regulatory scrutiny is unclear as RBI may tend to look into the timeline – when the capital came in, when the forward deals were struck, which of these are now claimed as hedges, how they were accounted for, etc. Also, are there communications between India and the HQ to back the explanation?” said another person.THE NDF DEALS
When the rupee comes under pressure, banks cut arbitrage deals by buying dollar forward in India and selling dollar forward in the NDF market which has been flourishing in London, Singapore, Hong Kong, and New York since the ‘90s when foreign portfolio managers,hedge funds and others explored ways to bet on the USD-INR rate following partial convertibility of the rupee.

Typically, when geopolitical turmoil and sell off by foreign funds pulls down INR, the USD trades a little stronger (and INR quotes a tad weaker) in NDF compared to the onshore market. So, the USD-INR rate is higher in NDF than the forward USDINR rates in India.
MNC and Indian banks cash in on this by buying USD in the onshore forward market, and simultaneously selling USD-INR in the NDF market. Forward contracts with tenures of one to three months are the most liquid.

RBI came down heavily as the banks with their arb deals were providing liquidity to hedge funds and other international speculators who were shorting the INR. When these players shorted INR, they went long on USD and therefore bought USD-INR forward contracts in NDF. Their counterparties were the Indian banks selling USDINR forwards in the NDF – the offshore leg in the two-legged arbitrage deals.

REGULATORY BYPASS
The central bank, which rushed in with restrictions in two phases, had also taken an exception to the practice of corporates in India, who cannot access the NDF, using banks to enter the offshore market. Since USD-INR was slightly higher in NDF, large corporate exporters would sign forward deals with banks in India which did a backto-back deal in the NDF market to offer the companies rates that are very close to the NDF rate – thus, allowing clients to convert more rupees from their export proceeds. This partly shifted liquidity from the onshore to offshore market.

While a forex dealer or a corporate treasurer may find such company-bank-NDF deals kosher, legal practitioners would find them in violation of the central tenet of the Foreign Exchange Management Act: what cannot be done directly, cannot be done indirectly.

The long-short ratio-the proportion of bullish (long) positions to bearish (short)-of foreign portfolio investors’ Nifty futures wagers rose to 22% on Friday, close to the 18-21% range seen in the last week of February before the start of the US-Iran clash on February 28.

The reading had fallen to 9.9% on March 13 and stayed between 10% and 18% for most of the fighting period as these investors had increased the hedges against their portfolios. The ratio had made a lifetime low of 5.98% on September 30, 2025.

ET Bureau

The short covering came amid Nifty’s weekly gains of 5.9% until Friday, when it ended at 24,050.6, its highest closing level in a month.

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“FIIs had begun covering shorts in the derivatives segment in the past few days, signalling early reversal cues,” said Nilesh Jain, head of technical and derivatives research, Centrum Finverse.. “Friday’s return to buying in the cash market after multiple sessions is a positive development and could support further pullback alongside continued short covering.”
FPIs were buyers to the tune of ₹672 crore in the cash market on Friday, after remaining sellers in all trading sessions in March and April so far. Further cuts in bearish positions will depend on the progress of the US-Iran talks, which began on a sour note over the weekend . “While the long-short ratio has improved due to short covering, we do not see many fresh long additions, suggesting that FIIs remain cautious rather than bullish,” said Siddarth Bhamre, head of institutional research at Asit C Mehta. “Continued selling in cash markets with one day of pause is not a sign of a U-turn in sentiment.” Since end of September 2024, when the downtrend in Indian equities kicked in, the long-short ratio of FPIs’ Nifty futures positions has mostly stayed between 10% and 20%, indicating predominantly bearish bets. Before the slide started, the reading was at 81%.

Somil Mehta, head of retail research at Mirae Asset Sharekhan said the shift in the ratio is yet to show foreigners are back to their bullish ways. “Sustained improvement in their sentiment will depend on stability in global factors like crude oil prices and geopolitical developments,” he said. The progress in companies’ fourth quarter earnings will be one of the factors for foreigners to revisit their stance on Indian equities.

“If earnings remain under pressure, valuations may not be attractive to foreign investors. They are also likely to wait for currency stability in India,” said Bhamre.