The Reserve Bank of India (RBI) on October 10 tightened rules governing the foreign exchange market, restricting the rebooking of cancelled rupee-linked derivative contracts and sharply reducing the threshold for undertaking certain forex derivative transactions without establishing underlying exposure.
The measures come amid evolving conditions in the foreign exchange market and are aimed at ensuring its orderly functioning, the central bank said in a press release.
Under the revised norms, authorised dealers will not be permitted to allow users to rebook any foreign exchange derivative contract involving the rupee, whether deliverable or non-deliverable, if it was cancelled with an authorised dealer after the issuance of the directions. Rollover of contracts on maturity will continue to be permitted, subject to existing regulatory requirements.
The RBI has also reduced the threshold for undertaking foreign exchange derivative transactions to hedge contracted exposures without establishing the existence of the underlying exposure to $5 million from $100 million. The revised threshold applies across all authorised dealers.
The corresponding limit for taking positions in exchange-traded currency derivatives involving the rupee without establishing underlying exposure has also been lowered to $5 million from $100 million, across all recognised stock exchanges taken together.
Additional checks on exposures
The central bank has tightened documentation requirements to prevent the same underlying exposure from being hedged through multiple authorised dealers.
Authorised dealers will now have to obtain and retain an undertaking from users entering into rupee-linked foreign exchange derivative contracts to hedge contracted exposures, confirming that the same underlying exposure has not been hedged with another authorised dealer.
The RBI has also introduced a Foreign Exchange Risk Reserve (FERR) requirement for certain rupee-linked derivative transactions.
Under the new framework, authorised dealers will be required to maintain a cash reserve with the RBI equivalent to 20 percent of the rupee value of the notional amount of each transaction exceeding $2 million. The requirement applies to rupee-linked foreign exchange derivative contracts undertaken to hedge current account exposures where the user purchases foreign currency against the rupee.
Liquidity management
The RBI is also tightening liquidity conditions through changes to daily cash reserve ratio (CRR) maintenance norms. From the fortnight beginning October 16, banks will have to maintain at least 99 percent of their prescribed CRR on a daily basis, up from 90 percent earlier, although the overall CRR ratio remains unchanged.
The change comes alongside the RBI’s announcement on October 9 of an open market operation (OMO) sale of government securities worth Rs 25,000 crore, scheduled for October 13, to absorb surplus liquidity. Market participants said the higher daily CRR maintenance requirement would reduce banks’ flexibility in managing day-to-day liquidity, alongside the central bank’s OMO sales.
The forex measures are intended to strengthen market discipline and ensure appropriate risk management in the foreign exchange market, while maintaining an orderly and transparent market environment, the RBI said.
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