The Reserve Bank of India (RBI) has tightened its cash reserve rule for rupee-related foreign exchange derivatives. The move restricts overseas clients to using certain non-deliverable rupee derivatives only for hedging.
The central bank has also extended the 20% cash reserve requirement to banks’ own rupee currency hedges. These measures are part of a broader effort to support the Indian rupee, which has faced pressure from high oil prices and capital outflows.
The RBI announced the latest changes on Monday, following a series of steps introduced over the weekend. The rupee rose 1% on Monday after the announcements, recovering some ground after falling more than 6% this year.
Key highlights:
- The RBI has limited certain overseas clients to hedging through non-deliverable rupee derivatives.
- Banks must maintain a cash reserve equal to 20% of the rupee equivalent of specified derivative contracts.
- The rupee gained 1% on Monday following the central bank’s recent measures.
How Does the RBI’s Cash Reserve Rule Work?
Under the revised rules, banks operating through units in India’s International Financial Services Centre (IFSC), along with certain primary dealers, can offer non-deliverable rupee derivatives to non-resident users only for hedging.
Previously, these institutions could offer such contracts to overseas clients for a wider range of purposes. The new restriction narrows their permitted use to managing currency risk rather than other trading activities.
Non-deliverable derivatives are settled in cash, usually in US dollars. Unlike deliverable contracts, they do not require the actual exchange of rupees when the contract is settled. The RBI has also required authorized dealers to maintain a foreign exchange risk reserve for rupee-related derivative contracts used to hedge their own assets and liabilities.
The requirement applies to contracts in which an authorized dealer buys foreign currency against the rupee. The reserve must equal 20% of the rupee equivalent of each contract’s notional amount.
Banks must deposit this reserve in cash with the RBI daily and keep the funds there until the contract ends. This increases the amount of cash banks must set aside for the covered transactions.
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Why Has the RBI Tightened Forex Hedging Rules?
The latest measures come as the rupee faces pressure from elevated oil prices and capital outflows. Higher oil prices can increase India’s demand for foreign currency because the country relies heavily on imported crude oil.
The central bank’s recent actions aim to address pressure on the currency. However, the longer-term impact will depend on market conditions and foreign exchange demand.
Reuters reported on Monday that banks had asked the RBI to withdraw the 20% cash deposit requirement for foreign exchange derivatives used to hedge current-account exposures. Instead, banks proposed a flat fee for these transactions.
The request highlights concerns about the cost of maintaining cash reserves for currency hedging. The RBI’s decision to extend the requirement to banks’ own covered hedges means the rule now applies more broadly.
The rupee’s 1% rise on Monday followed the central bank’s weekend announcements. While the recovery marks a move in the currency’s favor, it does not establish whether the measures will provide lasting support.
For banks and overseas market participants, the revised rules mean tighter limits on certain derivative transactions and additional cash requirements for covered hedges. Their effects will become clearer as financial institutions adjust to the new framework.
