Options markets continue to signal a bearish medium-term outlook for the rupee, suggesting that the RBI’s measures may offer short-term relief rather than address underlying depreciation pressures.
Mr. Apoorva Javadekar,
Chief Economist,
Shriram Research
Mumbai, 24 October, 2026: The RBI announced a series of FX measures between Oct 10–15, 2026, to arrest INR depreciation, which had approached 97. The measures focus on curbing speculative FX derivative activity, requiring banks to post cash against derivatives involving INR sales via the Foreign Exchange Risk Reserve (FERR), and tightening scrutiny of large overseas investments. • While USD/INR spot recovered its September losses to trade at 94.50 on October 21, genuine hedging costs rose sharply for Indian importers, with the 3-month forward premia widening by 135 basis points to 6.7% (annualized) as banks passed on the FERR opportunity cost to clients. • While spot has recovered, the options market signals persistent 12-month bearish sentiment on the INR, with the 25-delta risk reversal continuing to price INR puts over calls, reflecting the market’s view that the RBI’s measures offer near-term relief rather than a structural reversal of depreciation pressure. • Markets and foreign investors will look for a durable financing strategy to support India’s widening current account deficit. The merchandise trade deficit grew 17% YoY to $146bn during April–August 2026, while the services trade surplus covered only 59% of the merchandise deficit, down from 64% a year ago — a deteriorating offset that, alongside elevated oil prices, underpins neutral-to-bearish medium-term sentiment on the INR. • RBI’s FX reserves of $725 bn appear adequate on the surface, but narrow once we net out $200 bn of forward dollar commitments, including FCNR(B) obligations. • Overall, we view the RBI’s measures as short-term stabilizers; however, we expect the INR to drift down, driven by Weaker BoP fundamentals, high global yields competing with EM sovereigns for capital, and elevated FX hedging costs — a direct consequence of the FERR — themselves capping short-term FII equity inflows.
RBI’s FX Measures
The FX space is getting dynamic as the RBI’s 10th October measures aim to stabilize the INR, while IMF officials cautioned against excessive FX intervention, highlighting the limited durable benefits and making a case for allowing the currency to adjust to global shocks. The RBI’s FX measures aimed to arrest the INR’s 2% slide since September to near 97/$, and a surge in one-way importer hedging demand for forward dollar purchases to $64 bn in Sept (up 44% y/y), helped the INR recover by 2.4% since the measures to 94.46. Continued FX intervention and FII inflows into the Jio IPO further helped the INR recover. The measures include: 1. A dedicated dollar window for OMCs to source their daily USD requirements via SBI 2. A requirement for banks to set aside 20% in Foreign Exchange Risk Reserve (FERR) on FX derivatives (exceeding $ 2 mn in notional value) involving INR sale by the user, including hedging contracts, the bank’s own FX management activities, but excluding the bank’s market-making activities. 3. A reduction in the threshold for users from $100 mn to $5 mn to take a derivative position without documenting underlying FX exposure 4. Banning immediate rebooking of canceled forward contracts to curb profit-booking on hedges 5. Restrictions on IFSC banking units to offer non-deliverable derivatives for non-hedging purposes. 6. Tightened Scrutiny on Overseas Direct Investment exceeding $1bn, requiring detailed information on the transaction.
Assessment of Measures
A dedicated OMC dollar window is likely to re-route $10-12bn of monthly USD purchases from the open market to a special window, lowering day-to-day FX volatility and speculative trades that track oil price swings. However, OMC dollar demand, which will now flow directly into the RBI’s FX reserves, could drag reported FX reserves by $60-$70bn by fiscal year-end, and compound the optics around FX reserves already challenged by the RBI’s large short forward dollar position, estimated at around $200-220bn. The RBI substantially narrowed the scope for speculation by reducing the threshold for users to take a derivative position without documenting underlying FX exposure from $100mn to $5mn. Separately, the ban on the cancel-and-rebook mechanism addresses a specific speculative loop: users with a conviction on INR depreciation would book a forward contract, cancel it when the INR fell to book profits, and immediately rebook at the weaker level — amplifying INR’s depreciation. The RBI Governor flagged that a very high proportion of FX trades were being canceled.
Impact of FERR
Motivation: Banks typically buy USD in the spot market to cover their forward USD deliverables, translating forward USD demand into spot INR pressure. The FERR was introduced precisely to limit the forward-to-spot feedback loop by making forwards costlier and limiting forward activity.
How Costly Can Forwards Get?
FERR can be thought of as a wedge that distorts forward pricing away from implied by rate differentials. With a Repo of 5.5%, a FERR of 20% notional value incurs a minimum annual opportunity cost of 20% × 5.5% = 1.1% (110 bps), and full pass-through implies that annualized forward premia could rise by 1.1 percentage points (pp). However, the opportunity cost of FERR could be as high as 8%-10%, since these funds could otherwise have been loaned out given the banking system’s already high credit-deposit ratio. However, if INR spot durably stays firm on FERR, a more appropriate measure of cost should compare the current forward rate with the rate that would have prevailed ex-FERR, rather than the % forward premium. However, we do not see these measures as stabilizing INR durably, and argue for widening of forward premia % as an appropriate measure.
Spot and σ: The RBI’s measures came against the backdrop of INR’s isolated 1.92% fall from Sept to October 7, while broader EM currencies gained 0.25%. The Oct 10 measures, along with subsequent clarifications, helped fully reverse the INR’s September fall, as the INR gained 2.4% since Oct 10 while other EM currencies were flat against the USD. The measures also seem to partially reverse implied volatility embedded in USDINR from 5.03% to 4.8%. The options markets also point to less bearish sentiment for INR at 3M horizon, with a 25∆ risk-reversal (a measure of how expensive puts are relative to calls) halving from around 0.6 to 0.3 vol points from pre-to-post RBI measures. That said, 12M risk-reversal is flat around 0.9 volatility points, suggesting the market views these measures as largely short-term fixes and expects the INR to track currency fundamentals in the medium term.
Forwards: Consistent with FERR making forwards costly, forward premia continued to rise in offshore and onshore markets across tenors, with 3M and 12M USDINR forward premia widening by 135 bps and 53 bps, respectively, since Oct 10. This widening was on top of 232 and 82 bps of widening in 3M and 12M forwards since Sept, until the measures were announced. The FERR effect is more pronounced at the short end, where the cancel-rebook mechanism was prominent. Offshore vs Onshore forward cracks widened significantly after the RBI measures (from -30 bps on Oct-7 to +32 bps now), as offshore markets, in addition to FERR, were subjected to a “hedging-only ” restriction on NDFs offered by IFSC banking units.
Unintended Consequences: While intended to curb speculative activity, the FERR has raised the cost of genuine hedges, risking wider unhedged exposure, especially when USDINR σ is elevated. As is well known, unhedged corporates suffered significantly in the late 1990s when Brazil and other Latin American countries broke their pegs to the USD. An alternative policy that applied FERR on Net Open Positions (NOP) of banks/ADs or undocumented hedges could have curbed the speculative activity more efficiently, keeping the cost of genuine hedges contained.
PBoC Experience
FERR is similar to PBoC’s 2022 FX reserve requirement on foreign currency forward purchases. Yuan selling derivative activity dropped from a notional of $70bn to $10-15bn after the PBoC reserves in 2022. However, despite these reserves, the PBoC could not control the yuan’s medium-term depreciation. The muted response of 25∆ risk-reversal at a 12M horizon for INR, which stayed flat around 0.9 vol points around the RBI measures, suggests the market does not think these measures will arrest the medium-term fall in INR. The PBoC reversed the FX reserve requirement only in March 2026, suggesting such maneuvers could persist for multiple years and significantly affect Indian corporates’ hedging behavior.
India’s External Account
April-August BoP: India posted a balance of payments (BoP) surplus of $58 bn during April-August 2026 (relative to a $0.8 bn deficit in 2025 for the corresponding period), largely driven by $119 bn in net NRI deposits mobilized via the FCNR(B) scheme. Services, with a $85 bn surplus, covered 59% of the $146 bn merchandise deficit, and stronger personal remittances/transfers from NRIs at $66.8 bn helped cover the balance. However, services covered 59% of the goods deficit in 2026, relative to 64% in 2025. Indian IT giants’ ability to deliver AI solutions to global clients matters as much for their stock prices as it does for financing India’s BoP. A silver lining is that FDIs recovered to $13.8 bn in Apr-Aug 2026 (up from $9.6 bn in Apr-Aug 2025).
Financing CAD:
With a $32 bn exodus of FII from equities, and most large-scale FDI announcements taking several more years to materialize into FDI, foreign investors are looking for signs of durable CAD financing. As oil prices stay above $100/barrel, CAD could widen to 1.5% of GDP, still manageable but hard to finance as high global yields and risk-off portfolios imply less foreign capital flowing to EM in general, including India. High-quality hyperscalar debt has been posing serious competition to EM sovereign debt
On RBI FX Reserves - on paper vs usability trade-off:
The RBI’s FX reserves fell from $785 bn at the start of September to $726 bn on Oct. 9. While part reflects potential valuation losses on gold and non-US assets with a stronger USD, a major chunk reflects active RBI intervention in the FX market. Additionally, with around $200-$220 bn of short dollar forward book (including FCNR (B) related forward commitments), the net FX reserves look modest at around $500 bn, covering 7.5 months of imports. The RBI is prioritizing retiring the near-term forward book and extending maturities beyond 1 year, giving it leeway to use FX reserves before the forward dollar commitments come up for retirement. That said, the optics on FX reserves are challenged by the RBI’s net short forward book — estimated at $200bn — a meaningful portion of which matures around late 2028 and through 2029, coinciding with India’s general elections, when FIIs/FDIs are likely to adopt a wait-and-watch stance, which could amplify pressure on INR around elections.
Conclusion
We view the RBI’s recent FX measures as short-term stabilizers — not necessarily unjustified, but insufficient to alter the medium-term bearish outlook on the INR. Four structural headwinds persist: elevated crude oil prices at $110/barrel are widening the current account deficit beyond consensus forecasts, with the CAD now tracking toward 1.5–2.0% of GDP in FY27; high global yields continue to compete with EM sovereign bonds, capping the capital account offset that has so far sustained the overall BOP surplus; elevated FX hedging costs — with the 3M forward premium having widened to 6.4% p.a. post-FERR — are themselves a self-inflicted constraint on short-term FII equity inflows; and a widening India–US inflation gap (currently +1.8pp and rising) reinforces the structural case for INR depreciation over the medium term, consistent with purchasing power parity dynamics that have held over multi-year horizons.
