RBI tightens forex derivative rules and adds 20% cash reserve on hedges

The Reserve Bank of India has overhauled regulations governing rupee foreign exchange derivatives, clamping down on corporate flexibility to rebook cancelled positions and slashing the ceiling for taking hedges without documentary proof of underlying exposure.

Under the directions issued to authorised dealers, banks are prohibited from letting corporate users rebook any deliverable or non-deliverable rupee derivative contract once it has been cancelled. Rollovers at maturity remain permitted under existing guidelines, but companies can no longer cancel a hedge to book a fresh one on the same exposure with any authorised dealer.

What changes for corporate hedging

For years, businesses could enter rupee derivative trades to hedge contracted exposures up to $100 million across all authorised dealers without first establishing that an underlying transaction existed. The central bank has cut that threshold to $5 million.

A matching restriction applies to exchange-traded currency derivatives, where the combined position limit across all recognised stock exchanges without established exposure has also been reduced from $100 million to $5 million.

To prevent companies from hedging the same commercial transaction across multiple lenders, the central bank now requires banks to obtain and retain a formal undertaking from clients. The document must explicitly confirm that the underlying exposure has not been hedged elsewhere.

The new cash reserve requirement

The central bank has also introduced a Foreign Exchange Risk Reserve (FERR) to raise the cost of aggressive corporate dollar accumulation.

For any rupee derivative contract with a notional value exceeding $2 million equivalent undertaken to hedge current account liabilities where a user buys foreign currency against the rupee, authorised dealers must park a 20% cash reserve with the RBI. The reserve is calculated on the rupee value of the transaction's notional amount.

Why the central bank intervened

The regulatory tightening follows sharp pressure on the domestic currency and a swift drawdown in external buffers. India's foreign exchange reserves shrank by almost $52 billion in four weeks, falling from $785.7 billion on 4 September to $734 billion by 2 October.

Over the same period, the rupee fell by nearly 40 paise to 96.73, weighed down by escalating conflict in West Asia, elevated crude oil prices, rising US treasury yields and sustained selling by foreign portfolio investors in Indian debt and equity markets.

Alongside the derivative curbs, the central bank initiated direct dollar sales to three state-owned refiners—IndianOil, Bharat Petroleum and Hindustan Petroleum—to supply their crude import requirements away from the spot market. Taking state oil refiners out of public currency dealing prevents their predictable monthly dollar requirements from worsening exchange rate volatility.