RBI Rule Tanks Rupee Derivatives Trading

RBI’s New Hedging Rule Expected to Slash India’s Currency Derivatives Trading by 80%

The Reserve Bank of India’s (RBI) new regulation requiring exchange-traded rupee derivative transactions is expected to cause a dramatic plunge in trading volumes. According to industry experts, the decline can be more than 80%, potentially crippling a significant segment of the Indian forex market.

Implemented on April 5th, 2024, the rule has been met with concerns from exchange trade fund brokers. They fear it will drive away a large portion of market participants. Previously, participants could hold rupee derivative contracts up to $100 million without demonstrating underlying exposure. Now, the rule mandates that all such transactions must be linked to a legitimate underlying business need, such as import or export contracts.

Table of Contents

Impact on Market Makers

“Once this rule comes into effect, we expect a more than 90% fall in our volumes,” said Arnob Biswas, head of forex research at SMC Global Securities. “The market volumes will likely drop by a similar margin. From our point of view, this market is practically over, at least for the time being.”

Even though it’s not well appreciated among professionals, RBI contends the change will strengthen the INR currency by curbing speculative trading. However, critics argue it will also reduce liquidity, potentially harming small and medium-sized companies seeking to hedge currency risks.

Shifting Landscape

Data from the National Stock Exchange (NSE) indicates that over 80% of currency trading in India derivatives volume could vanish. Brokers argue that the restrictions will limit access to risk management tools for small and medium-sized companies (SMEs) who are genuine hedgers. Additionally, a shift in hedging activity towards the less regulated over-the-counter (OTC) market is possible.

The impact on foreign investors remains unclear. While some may adapt to the hedging requirement, others may move their business offshore.

Historical Context

Exchange-traded rupee derivatives were introduced in 2008 and have grown significantly since then. Average daily trading volumes on dollar-rupee futures have climbed from $142 million in 2008 to $2.5 billion in 2024, highlighting the segment’s importance to the Indian forex market.

The long-term effects of the RBI’s new rule remain to be seen. While it aims to promote stability, it may also lead to unintended consequences for market depth and accessibility.