Foreign Exchange Risk Reserve (FERR)

Context of the News

What Is FERR?

• Banks must set aside 20 per cent of any forex derivative contract above $2 million involving the rupee
• The amount is kept in cash with the RBI
• The RBI can change the percentage as conditions require
• It earns no return for the bank

What Does It Actually Do?

• It makes protection against a fall in the rupee more expensive
• Banks must lock up cash against every such contract, so they price the hedge higher or offer fewer of them

Why Discourage Hedging?

This is the point that needs careful understanding:

• Hedging is normally good practice — importers protect themselves from a falling rupee
• But to hedge, you must buy dollars forward
• That adds to dollar demand today
• Which pushes the rupee down further
• So when a currency is already under pressure, hedging activity deepens the fall
• FERR raises the cost of that activity, slowing it

How Is This the China Model?

• China has long used a Foreign Exchange Risk Reserve Ratio of 20 per cent
• In March 2026, China cut its ratio to zero — because the yuan was strengthening, and it wanted to remove the cost of betting against its own currency
• India has done the reverse, introducing the ratio because the rupee is weakening

Key Terms

• Forex derivative: A contract whose value depends on a future exchange rate — a forward, future, option or swap
• Hedging: Buying protection against an adverse future price or rate movement
• Underlying: The actual exposure a derivative is meant to protect — such as an import bill
• Rebooking: Cancelling a hedge and taking a fresh one at a better rate; often used to speculate rather than protect
• Speculative demand: Buying a currency to profit from its movement, not because it is needed for a transaction
• Structural demand: Regular, unavoidable demand — such as oil companies needing dollars every month