RBI Tightens Forex Derivatives Framework to Ensure Market Stability

The Reserve Bank of India (RBI) has announced a comprehensive set of measures to strengthen the foreign exchange derivatives framework, aimed at promoting orderly functioning of the forex market.

These initiatives are introduced against the backdrop of increased pressure on the Indian rupee, which has been weakening against the US dollar, raising concerns about potential depreciation beyond critical levels.

Key among the restrictive measures is a prohibition on authorised dealers allowing clients to rebook any foreign exchange derivative contracts involving the Indian rupee (INR), whether deliverable or non-deliverable, that have been cancelled after the new directions take effect.

The central bank has also lowered the threshold for undertaking forex derivative transactions to hedge contracted exposures without establishing the existence of underlying exposure from $100 million equivalent to $5 million equivalent, applicable across all authorised dealers.

Similarly, the limit for taking positions in exchange-traded currency derivatives involving INR without underlying exposure has been reduced from $100 million to $5 million equivalent, aggregated across all recognised stock exchanges.

Authorised dealers are now required to obtain and retain an undertaking from users entering into forex derivative contracts involving INR, confirming that the underlying exposure has not been hedged with any other authorised dealer, to prevent duplicate hedging.

For all forex derivative contracts involving INR with a notional value exceeding $2 million equivalent, authorised dealers must maintain a Foreign Exchange Risk Reserve (FERR) in cash with the RBI, equal to 20% of the INR equivalent of the notional amount. This applies specifically to contracts hedging current account exposures where foreign currency is purchased against the INR.

V Rama Chandra Reddy, Head of Treasury at Karur Vysya Bank, noted that the introduction of the 20% cash FERR on larger transactions will add liquidity costs and discourage excessive positioning, with the primary goal being to curb speculative activities and ensure derivatives are used for genuine risk management.

He further observed that while banks may encounter higher compliance and liquidity expenses, customers engaged in legitimate hedging might face additional documentation and potential repricing. The measures are expected to moderate speculative behaviour and foster orderly market conditions, though the rupee’s trajectory will remain influenced by global factors and dollar supply dynamics.

In a parallel effort to address immediate dollar demand, the RBI has decided to open a special window to meet the entire daily dollar requirements of three public sector oil marketing companies: Indian Oil Corporation, Hindustan Petroleum Corporation, and Bharat Petroleum Corporation.

Under this facility, the central bank will facilitate the sale of US dollars to these oil marketing companies through designated banks, with the arrangement effective from October 12, 2026, and continuing until further notice.

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