The Reserve Bank of India’s Foreign Exchange Risk Reserve, or FERR, applies a 20% reserve requirement to specified rupee-linked derivatives used to buy foreign currency against current account exposures. Its apparent objective is to restrain the dollar demand generated when importers increase protection against depreciation, while temporarily withdrawing rupee liquidity.

The instrument has a Chinese precedent.

The People’s Bank of China introduced a 20% risk reserve on banks’ forward foreign exchange sales in 2015 and restored it in 2018 and September 2022. The parallel concerns a specific instrument, not China’s entire currency regime.

In its 2018 explainer, the PBOC described the transmission mechanism. When companies buy foreign currency forward, banks may hedge their exposure through spot purchases. Those purchases can weaken the currency and encourage further forward buying. The reserve requirement works through banks’ pricing to interrupt this feedback, without banning hedging transactions.

Changing Incentives
India faces a similar imbalance: importers increase forward dollar purchases as the rupee weakens, while exporters become less inclined to sell future dollar earnings. FERR appears designed to discourage that asymmetry by making importer cover more expensive.

The reserve requirement could increase importer hedging costs by approximately 1.5%; according to IDFC First Bank, the actual burden would depend on banks’ pricing.

Higher costs could encourage shorter hedge tenors, reduced cover or deferred purchases. Less forward dollar demand could ease premiums and spot-market pressure, while greater currency stability might encourage exporters to hedge. Lower market premiums, however, would not necessarily mean cheaper protection after including the reserve cost.

The Chinese precedent is instructive because the instrument was explicitly conceived as countercyclical. By making forward dollar purchases more expensive during depreciation episodes, the central bank sought to prevent hedging behaviour from amplifying exchange rate movements. The requirement could subsequently be relaxed when currency conditions stabilised.

The requirement also absorbs rupee liquidity. That withdrawal depends on the volume and duration of affected contracts and how long the measure remains in place. It is therefore distinct from a permanent increase in conventional CRR, although it complements the effort to tighten monetary conditions.

Risk Transfer
The difficulty is that a commercial hedge can be individually prudent while contributing to collective pressure on the currency. Charging more for protection does not distinguish an importer managing an unavoidable payment from one accelerating purchases because depreciation seems assured.

Reducing forward cover leaves the underlying dollar obligation intact. It may defer demand rather than eliminate it, while exposing the importer to further depreciation. Lower hedging volumes would consequently be an incomplete measure of policy success. Assessment should therefore track not just forward volumes and premiums, but also hedge tenors and the currency exposure businesses retain as they adjust to the measure.

Nor can FERR repair the underlying balance of payments, which will mainly be supported by the special swap-window inflows. Its plausible objective is narrower: moderate the pace of depreciation and reduce the pressure for a more aggressive interest rate response, rather than reverse the currency’s fundamental direction.

China's experience also requires qualification. Its reserve requirement operated within a more tightly managed exchange rate framework, supported by broader controls over capital movements. India cannot assume that an identical instrument will produce identical outcomes in a different market structure.

China’s experience also argues for reversibility. It reduced the reserve requirement to zero from March 2, 2026. The RBI should similarly specify the conditions under which this additional cost will be reviewed or removed. An instrument intended to contain self-reinforcing currency pressure should not become a permanent penalty on commercial risk management.