RBI’s Rupee Measures Curb Speculation, But Importers And Banks Face Higher Foreign Exchange Hedging Costs

The Reserve Bank of India’s (RBI) efforts to curb speculation in the currency market have helped support the rupee. However, the tighter rules are creating an additional cost for businesses that use currency derivatives to protect themselves against exchange-rate fluctuations.

Importers could feel the impact most directly. Higher hedging expenses may further force some companies to reconsider how much of their dollar exposure they choose to cover.

Tighter RBI Rules Put Pressure On Banks

An important change is the introduction of the Foreign Exchange Risk Reserve (FERR). Banks must set aside cash reserves equivalent to 20% of the value of eligible foreign exchange derivative contracts exceeding $2 million.

The money cannot be used for lending while the relevant exposure remains outstanding. Banks may therefore pass some of the cost on to customers through higher charges for hedging transactions.

The RBI has also lowered the threshold for certain foreign exchange derivative transactions without underlying exposure from $100 million to $5 million. In addition, cancelled rupee-linked derivative contracts can no longer be rebooked, although rollovers at maturity are still permitted.

Importers Face Higher Costs As RBI Defends The Rupee

For importers, the immediate concern is the cost of hedging payments against a falling rupee. If hedging becomes more expensive, some companies may choose to leave part of their dollar exposure uncovered. That could expose them to greater losses if the currency weakens again.

The restrictions could also affect forward premiums. A change in demand for forward dollars may influence these premiums, although the direction and scale of the impact will depend on market conditions.

The RBI has separately stepped in to meet the dollar requirements of state-owned oil marketing companies through a dedicated facility. The arrangement is intended to reduce their direct demand for dollars in the spot market.

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