India’s RBI Clarifies Scope of Forex Curbs After Market Swings

India’s central bank said its recent derivative restrictions will only apply to deals for hedging forex risk and not for market-making, providing a clarification after sharp swings in currency forward markets.

The foreign-exchange risk reserve will be applicable to banks’ own assets and liabilities hedged through derivative contracts when they purchase foreign currency against the rupee, the Reserve Bank of India said in a statement on Thursday.

The central bank added lenders will not have to set aside cash when such transactions involve sale of foreign currency. It also said that the measure is only for hedging current account transactions. Such deals typically include import and export flows.

“The RBI’s clarification provides some relief for banks and may result in a decline in the longer-term dollar-rupee forward premium rates,” said Dilip Parmar, currency analyst, HDFC Securities, referring to hedging costs.

The monetary authority announced sweeping market curbs over the last few days to deter speculation against the rupee which was approaching record lows. The risk reserve, a new measure, requires lenders to maintain with the RBI a holding of the rupee equivalent of 20% of the notional amount of each derivative transaction that exceeds $2 million.

Thursday’s statement comes after banks told the RBI that its restrictions were drying up liquidity in the currency forwards market and asked for clarity on the extent of the curbs. Dollar-rupee onshore forward yields, which represent the cost of locking in future purchases of the greenback by importers, surged to their highest in more than five years this week.

The RBI also said derivatives used for hedging interest on external borrowings or dividends paid to overseas investors would be excluded from the risk reserve.

Read More: Lenders Flag Freeze in Rupee Forwards, Market Distortions to RBI