UPSC Darpan

EconomyGS311 October 2026

RBI sets a 20% Foreign Exchange Risk Reserve on big forex contracts and opens a dollar window for oil marketing companies

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The news

Mumbai, October 10. With the rupee at 96.73 to the dollar on October 9, near its record low, the RBI said in press releases that banks must keep a Foreign Exchange Risk Reserve (FERR), in cash with the RBI, equal to 20% of the rupee value of any rupee–forex derivative above $2 million that hedges a current-account payment in which the user buys foreign currency. It is a reserve on banks, not automatically a fee on customers, The Indian Express notes. The limit for contracts taken without proving an underlying exposure falls from $100 million to $5 million, on all markets; a cancelled contract cannot be rebooked, though rollover at maturity is allowed. From October 12 the RBI will also sell dollars through designated banks to meet the entire daily needs of IOCL, HPCL and BPCL, about $300 million a day by The Hindu’s estimate.

The chain in one line: The Iran war lifts Brent to $104.4 → oil bills and $26.3 billion of FII outflows raise dollar demand → forward buying and bets feed the rupee’s fall → the October 7 repo hike fails → the RBI taxes big hedges and takes oil demand off the market

Static syllabus linkage

  1. FEMA, 1999 makes the RBI the regulator of the forex market. FEMA replaced FERA, 1973 and made forex violations civil offences. Banks deal as RBI-licensed “authorised dealers”, directed through A.P. (DIR Series) circulars; these rules came as Circulars No. 25 and 26.
  2. The rupee is market-determined, but the RBI manages volatility. The Liberalised Exchange Rate Management System of 1992 began a dual rate, unified into a market-determined rate in March 1993. The rupee is convertible on the current account since August 1994 but only partly on the capital account. The RBI aims to curb volatility, not defend a level.

Why UPSC loves this

  1. GS3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment”. Exchange-rate management and capital controls recur in both papers.

Prelims nuggets

  • FEMA, 1999 replaced FERA, 1973; contraventions under FEMA are civil, not criminal, offences.
  • India moved to a unified, market-determined exchange rate in March 1993.
  • The rupee has been convertible on the current account since August 1994, when India accepted Article VIII of the IMF’s Articles of Agreement.
  • A non-deliverable forward (NDF) is settled by paying only the difference in a convertible currency, usually offshore.

Analysis

  1. Hedging and speculation use the same contract, so the RBI regulates size and repetition, not intent. An importer who fixes today the rate for a payment due in three months is hedging, insuring against loss; someone who buys dollars forward with nothing to pay is betting on a weaker rupee. Banks cannot read intent, so the RBI demands proof above $5 million and bans cancel-and-rebook switching. Genuine importers pay too: bankers told ET hedging becomes “almost impossible”.
  2. Lens — Market and State: herd speculation is a market failure, but the cure blunts the price signal. When everyone expects the rupee to fall, buying dollars early becomes self-fulfilling. Some bankers warn the curbs could distort the rupee’s market-determined value. A thoughtful official would treat them as a circuit breaker with a sunset date, since a price held away from fundamentals invites fresh bets.
  3. The oil window moves India’s biggest dollar bill from the market to the reserves. Removing the largest regular buyer from the spot market eases pressure at once, as in 2013. But reserves fell $12.95 billion to $734.60 billion in the week to October 2, and the window has no end date.

Possible Mains question

The RBI’s Foreign Exchange Risk Reserve aims to separate hedging from speculation. Critically examine whether such curbs are compatible with a market-determined exchange rate. (15 marks, 250 words)

Model approach

  1. Directive — Critically examine. Weigh both sides, then judge.
  2. Introduction — a rupee at 96.73 and a 20% reserve on big hedges. Name the three measures.
  3. Body — one-way bets are a market failure a regulator may correct. Value addition: $26.3 billion of net FII outflows this year.
  4. Body — the curbs tax genuine importers, and the oil window drains reserves. Flowchart: oil price → dollar demand → forward buying → weaker rupee.
  5. Conclusion — compatible only as a temporary circuit breaker. Sunset the curbs; fix the current account.

Administrator's brainstorm

As an RBI Executive Director, how do you answer importers who say the FERR makes hedging unaffordable?

I would check whether banks pass the full cost on, since the reserve is not a customer fee. I would publish a review date and, if small importers are hit hardest, consider raising the $2 million threshold.