Forex hedging gets trickier, but there may be a way out

Mumbai: Amidst new regulations in the foreign exchange market, banks and corporations are considering alternative methods to manage hedging, potentially opting for simpler rules that reduce paperwork. Companies employ forwards, options, and other derivative contracts with banks to hedge anticipated exposure on imports and exports.

Until recently, firms could buy or sell dollar forwards up to $100 million without providing documents like invoices and agreements with overseas partners. However, the Reserve Bank of India (RBI) recently reduced this limit to $5 million, increasing the compliance burden on banks to collect and verify every trade contract and document exceeding $5 million.

Some experts propose treating contracted exposure as anticipated exposure, allowing companies to buy or sell any amount of dollars forward without presenting documents for the former. In this scenario, documents are submitted later when the forex is paid or received, and banks will only bear the loss if the rate moves adversely.

While this approach may alleviate compliance issues, it could introduce operational difficulties due to increased documentation and clerical work. The anticipated exposure window appears cleaner and might be preferable for companies, but it comes with additional costs from the Foreign Exchange Risk Reserve (FERR). RBI has also mandated banks to maintain a cash reserve equivalent to 20% of the rupee notional amount for every derivative linked to forex purchases above $2 million.

Despite the RBI's support for stabilizing the INR through direct dollar supply to oil marketing companies, some industry experts, like Samir Lodha from QuantArt, question the effectiveness of the FERR on current account imports. Many importers, according to Lodha, are hedging to protect margins against a falling rupee, as they operate with thin margins.

Ritesh Bhusari, deputy treasury head at South Indian Bank, notes that the 20% risk reserve is reminiscent of China's measure in 2015, but cautions that history shows China's reserve only slowed the yuan's fall without reversing it. Additionally, the rupee's rally following March 2026 curbs proved short-lived.

On March 27, 2026, RBI capped banks' net open position at $100 million and restricted non-deliverable forwards while banning rebooking of cancelled contracts. However, these restrictions will remain in place, and it is up to banks whether they want to treat contracted exposure as anticipated exposure to lessen compliance burdens.

The RBI's circular does not distinguish between contracted and anticipated exposure, as FERR would still apply. Banks can choose to treat contracted exposure as anticipated exposure to reduce compliance burdens but not for speculative positions.

In light of these new regulations, senior bankers convened with officials from the Forex Dealers Association of India (FEDAI) on Sunday to discuss the implementation of the new rules. They covered aspects such as maintaining FERR reserves, the requirement for upfront documents, the consequences if a company fails to provide documents, and how banks can verify that a company isn't using the same underlying asset for rebooked contracts. Some banks might insist on documents even for deals below $5 million.