RBI Forex Measures: Rupee Volatility, Hedging Rules and Policy Trade-offs

Why the rupee is under pressure

The report identifies persistent US dollar strength, elevated global yields, a high crude import bill and geopolitical uncertainty as major depreciation pressures. Foreign portfolio outflows can reinforce these pressures by increasing demand for foreign currency as investors exit rupee assets.

For an oil-importing economy, higher crude prices increase the dollar requirement for imports. Rupee depreciation can additionally raise the domestic-currency cost of these purchases, creating imported-inflation pressures. These are underlying external-sector forces that market-conduct measures alone cannot eliminate.

• Higher global yields can reduce the relative attractiveness of rupee assets, depending on interest-rate differentials and perceived risk.
• Geopolitical uncertainty can simultaneously disrupt energy supplies and encourage a shift towards safer assets.
• Expectations of further depreciation can encourage earlier dollar purchases or delayed conversion of export receipts, potentially intensifying short-term pressure.

What the derivative restrictions change

Authorised Dealers cannot permit users to rebook cancelled INR-linked foreign-exchange derivative contracts, whether deliverable or non-deliverable, where cancellation occurs after the directions were issued. Rollover at maturity remains permitted subject to existing regulatory provisions: cancellation followed by rebooking and maturity rollover are therefore treated differently.

The threshold for hedging contracted exposures without establishing the underlying exposure falls from $100 million to $5 million equivalent across all Authorised Dealers. The corresponding threshold for INR exchange-traded currency derivatives also falls to $5 million across all recognised stock exchanges taken together. This is an exposure-verification threshold, not a general exemption from having an underlying exposure.

Authorised Dealers must obtain and retain an undertaking that the same underlying exposure has not been hedged with another Authorised Dealer. Together, these rules seek to limit duplicate hedging, repeated position-taking and inadequately verified derivative activity.

• The dealer-market threshold is aggregated across Authorised Dealers, not available separately at each bank.
• The exchange-traded threshold is aggregated across recognised stock exchanges, not available separately at each exchange.
• The reduced threshold does not prohibit larger genuine hedges; it brings more transactions within exposure-verification requirements.

How the Foreign Exchange Risk Reserve works

For eligible INR-linked derivative transactions with a notional value exceeding $2 million equivalent, Authorised Dealers must maintain a cash Foreign Exchange Risk Reserve with the RBI equal to 20% of the INR equivalent of each transaction's notional amount. Eligibility is confined to derivatives hedging current-account exposures where the user purchases foreign currency against INR.

The reserve is therefore not a blanket charge on every currency derivative. For a qualifying transaction above the threshold, the reported requirement is calculated on the transaction's full notional amount, not merely the portion exceeding $2 million.

Holding cash with the RBI can raise dealers' funding and opportunity costs. Banks may pass these costs to customers through wider spreads or higher hedging charges, including for longer-tenor contracts. This creates the central trade-off: discouraging excessive dollar-linked positions without making legitimate risk protection prohibitively expensive.

• The reserve obligation is imposed on Authorised Dealers, although customers may bear some economic cost.
• An import-related foreign-currency purchase hedge may qualify if it satisfies the stated conditions.
• An exporter selling foreign currency against INR does not fit the stated foreign-currency-purchase condition.

Market stabilisation is not a substitute for external adjustment

The report describes a broader toolkit including forex intervention, sell-buy swaps, a dedicated dollar facility for oil marketing companies, measures concerning external commercial borrowings and NRI deposits, and limits on banks' open currency positions. It presents the latest package as a shift towards targeted market measures after a reported repo-rate increase failed to halt depreciation.

Direct dollar supply to oil marketing companies can move concentrated import-related demand away from the interbank market and ease immediate spot-market pressure. However, it does not reduce the oil import bill or reverse capital outflows; direct supply can initially draw on the RBI's foreign-exchange reserves.

Orderly adjustment should be distinguished from defending a particular exchange rate. The rupee must retain room to respond to economic fundamentals, while intervention and prudential rules prevent disorderly trading from magnifying the adjustment.

• Interest-rate increases influence broader credit conditions, whereas derivative rules target particular market activities.
• Dollar facilities can provide a temporary bridge during market stress but cannot permanently replace foreign-exchange earnings.
• Tighter onshore rules could reduce liquidity or encourage activity to move elsewhere if compliance and hedging costs become excessive.