Rupee Depreciation – RBI Measures to Control Forex Volatility

Context

1. In October 2026, the Reserve Bank of India (RBI) announced measures to curb excessive speculation in the foreign exchange derivatives market.
2. The measures came amid pressure on the rupee due to a strong US dollar, high crude oil prices, foreign investment outflows and geopolitical uncertainty.
3. The RBI aims to maintain orderly forex-market conditions and reduce excessive volatility, rather than defend a fixed rupee–dollar exchange rate.

Understanding Rupee Depreciation

1. Rupee depreciation occurs when the value of the Indian rupee falls against another currency under a market-determined exchange-rate system.
2. For example, if the exchange rate changes from $1 = ₹80 to $1 = ₹90, the rupee has depreciated.
3. Impact of depreciation:
   1. Imports become more expensive in rupee terms.
   2. Exporters may receive more rupees when converting their dollar earnings.
   3. Repayment costs increase for borrowers with unhedged foreign currency loans.
   4. It can contribute to imported inflation and widen the current account deficit.

Major Causes of Rupee Depreciation

1. Strong US Dollar: Higher returns on US assets can attract global investments towards the US, increasing demand for dollars.
2. High Crude Oil Prices: Since India imports much of its crude oil, rising prices increase dollar demand and the import bill.
3. Foreign Portfolio Investment (FPI) Outflows: When foreign investors withdraw money from Indian markets, they may convert rupees into dollars, putting pressure on the rupee.
4. Geopolitical Uncertainty: Conflicts and disruptions to global energy supplies can increase oil prices and encourage investors to move towards safe-haven assets such as the US dollar.
5. Interest Rate Differentials: Relatively higher interest rates in the US may attract investors towards dollar-denominated assets, potentially causing capital outflows from India.

Why is Rupee Stability Important?

1. Inflation: Depreciation increases the rupee cost of imported crude oil, electronics and edible oils, contributing to imported inflation.
2. Current Account Deficit: A higher import bill, particularly for crude oil, can widen the current account deficit if export earnings do not increase sufficiently.
3. Corporate and Banking Stability: Companies with unhedged foreign currency loans face higher repayment costs, increasing credit risks for banks.
4. Investor Confidence: Sharp depreciation may encourage further foreign investment outflows, creating additional pressure on the rupee.

RBI’s Measures to Control Forex Volatility

On 10 October 2026, the RBI announced four major regulatory measures relating to rupee-linked foreign exchange derivatives.

Foreign exchange derivatives: These are financial contracts whose value depends on exchange rates. Businesses use them to protect themselves against currency fluctuations. However, they can also be used for speculative trading.

1. Restriction on Rebooking Cancelled Contracts
   1. Earlier, a person or company could cancel a currency-related contract and enter into a new one to benefit from changes in exchange rates.
   2. The RBI has now restricted users from making a fresh contract after cancelling an existing one.
   3. However, they can still extend an existing contract when it reaches its expiry date.
   4. Purpose: To prevent people from repeatedly cancelling and making new contracts just to profit from currency movements.
2. Reduction in Exposure Threshold
   1. Earlier, users could enter into certain foreign exchange contracts worth up to $100 million without proving that they had an actual need for foreign currency.
   2. The RBI has reduced this limit to $5 million.
   3. The same limit applies to the relevant exchange-traded currency derivatives.
   4. Purpose: To restrict large currency bets made without a genuine business requirement.
3. Additional Documentation Requirements
   1. Banks dealing in foreign exchange must now obtain a written confirmation from customers that they have not already protected the same payment or receipt through another bank.
   2. Purpose: To prevent the same foreign currency payment from being used to make multiple contracts and take unnecessary additional positions.
4. Introduction of Foreign Exchange Risk Reserve (FERR)
   1. For certain specified currency contracts exceeding $2 million, banks must keep an additional cash reserve with the RBI.
   2. This reserve is equal to 20% of the rupee value of the contract.
   3. The bank must maintain this amount with the RBI until the contract ends.
   4. Purpose: To make large currency contracts more costly and discourage excessive risk-taking.

Other RBI Interventions to Manage Currency Pressure

1. Special Dollar Window for Oil Companies: RBI supplies dollars to IOC, HPCL and BPCL through designated banks to meet their daily needs. This reduces their demand for dollars in the regular forex market, easing immediate pressure on the rupee.
2. Foreign Exchange Swaps: RBI exchanges dollars for rupees with banks and reverses the transaction on a future date. This helps manage the availability of dollars and rupees in the banking system.
3. Position Limits on Banks: RBI sets limits on how much foreign currency risk banks can take. This prevents banks from taking excessively large bets on currency movements.
4. Encouraging NRI Deposits: NRIs deposit their money in Indian banks. These deposits bring foreign currency into the banking system and improve the availability of foreign exchange.
5. External Commercial Borrowings (ECBs): Indian companies borrow money from lenders abroad. This brings foreign capital into India, but companies must repay these loans in foreign currency later.
6. International Rupee Invoicing: Special Rupee Vostro Accounts (SRVAs) allow foreign banks to hold rupee accounts with Indian banks. These accounts help settle international trade payments in rupees instead of relying entirely on the US dollar.

Implications of RBI’s Measures

1. Benefits
   1. Reduced Speculation: Restrictions on rebooking and large positions can discourage excessive speculative activity.
   2. Lower Short-term Volatility: Direct dollar supplies to oil companies can reduce their immediate demand in the interbank market.
   3. Better Transparency: Documentation requirements help prevent double hedging.
   4. Improved Risk Management: FERR increases the cost of certain large derivative positions.
   5. Greater Business Certainty: Orderly currency movements help businesses plan imports, exports and foreign currency payments.
2. Costs and Limitations
   1. Higher Hedging Costs: FERR and tighter derivative rules may increase costs for banks and businesses.
   2. Reduced Market Liquidity: Restrictions may reduce participation in the domestic forex market.
   3. Pressure on Forex Reserves: Direct dollar supplies by the RBI may involve using its foreign exchange reserves.
   4. Limited Long-term Impact: RBI intervention cannot permanently eliminate dollar demand arising from oil imports and capital outflows.
   5. Offshore Market Activity: Some participants may shift currency trading to offshore markets if domestic restrictions become costly.

Way Forward

1. Strengthen Exports: Improve export competitiveness and diversify export markets to increase foreign exchange earnings.
2. Reduce Energy Import Dependence: Expand renewable energy and diversify crude oil sources.
3. Attract Stable Capital Inflows: Encourage long-term foreign investment rather than relying excessively on volatile portfolio flows.
4. Deepen Domestic Forex Markets: Improve transparency, liquidity and access to genuine hedging instruments.
5. Maintain Macroeconomic Stability: Control inflation, strengthen external balances and maintain adequate foreign exchange reserves.

Conclusion

Rupee depreciation is influenced by global and domestic factors such as dollar strength, crude oil prices, capital outflows and geopolitical uncertainty. The RBI’s measures aim to curb excessive speculation and maintain orderly foreign exchange market conditions.

However, long-term currency stability requires stronger exports, reduced energy import dependence, stable capital inflows and sound macroeconomic fundamentals. The objective should be an orderly and resilient exchange rate, rather than defending an arbitrary rupee–dollar level.

Frequently Asked Questions (FAQs)

Q1. What is rupee depreciation?

Rupee depreciation refers to a market-driven fall in the value of the Indian rupee against another currency. It makes imports costlier and can increase imported inflation.

Q2. What are the major causes of rupee depreciation?

Major causes include a strong US dollar, rising crude oil prices, foreign investment outflows, geopolitical uncertainty and higher US interest rates that attract global capital.

Q3. How do RBI’s foreign exchange derivative restrictions help control volatility?

These restrictions discourage excessive speculative trading by limiting contract rebooking, reducing exposure thresholds, strengthening documentation requirements and increasing the cost of certain large currency positions.

Q4. What is the Foreign Exchange Risk Reserve (FERR)?

FERR requires banks to maintain an additional cash reserve with the RBI, equal to 20% of the rupee value of specified currency contracts exceeding $2 million, making large positions more costly.

Q5. Can RBI permanently prevent rupee depreciation through market interventions?

No. RBI interventions can reduce excessive volatility and manage short-term currency pressure, but long-term stability requires stronger exports, reduced energy import dependence, stable capital inflows and sound economic fundamentals.