Introduction
In April 2026, the Reserve Bank of India (RBI) introduced a significant regulatory intervention in the foreign exchange (FX) market by prohibiting banks from offering rupee non-deliverable forward (NDF) contracts to corporates. This step was taken in the face of increased FX volatility as part of an effort to discourage speculative FX trading, support the rupee, and regulate the FX derivatives markets.
This directive, although temporary, is likely to have significant implications for banks, corporates, and other aspects of foreign exchange dealings.
Understanding NDF Contracts and Their Role
Non-deliverable forwards (NDFs) are derivative contracts which allow parties to either speculate or hedge against currency risk without delivery of the underlying currency. The settlement of non-deliverable forwards is done through foreign currencies, mainly the US dollar, and are actively traded in international financial markets such as Singapore and London.
NDFs act as a very important hedging instrument for organizations which lacks access to domestic markets for the particular currency. However, they provide an avenue for speculative gains, especially when there are differences in the exchange rates prevailing in both domestic and international markets.
The RBI’s April 2026 Intervention
On April 1, 2026, the RBI issued a notification barring authorised dealers (banks) from offering rupee NDF contracts to both resident and non-resident corporates. The move came in response to sharp depreciation pressures witnessed in the rupee after it breached the ₹95 mark per US dollar.
The reason behind the RBI’s concern lay in the increased use of corporate arbitrage. Since the RBI had limited banks’ open position limit in the foreign exchange market to $100 million, banks began transferring exposure to corporates. This gave rise to a loophole through which corporates could indulge in arbitrage between the domestic and international markets.
This is why the RBI’s directive specifically mentioned that authorized dealers “shall not offer non-deliverable derivative contracts involving INR” to users.
Key Objectives Behind the Ban
- Curbing Speculative Arbitrage: The primary objective of the RBI’s measures was to ensure there would be no arbitrage opportunities that would increase currency volatility. The differences between the onshore and offshore markets had created an arbitrage opportunity for traders.
- Strengthening Monetary Control: Restricting derivatives whose value was based on offshore prices allowed the RBI to gain greater control over currency pricing and lessen the impact of speculative inflows from abroad.
- Promoting Genuine Hedging: It was further noted that although the use of offshore derivatives is banned, actual deliverable derivatives can be used as long as they are being used for hedging purposes only.
- Closing Regulatory Loopholes: This move effectively ended one loophole that companies were exploiting by taking advantage of existing laws to their benefit.
Market Impact of the RBI’s Move
- Immediate Currency Stabilisation: The effect of the measures taken by the RBI was instantaneous. There was a sudden strengthening of the rupee after the news was announced as there were lesser speculative pressures on the currency. As a result, market players needed to unwind their arbitrage positions, thus stabilizing the currency.
- Widening Onshore-Offshore Spread: The measures caused a widening spread between the onshore and offshore rates. It made offshore transactions costly for traders, thus achieving the objective of the RBI of discouraging offshore operations.
- Impact on Banks and Corporates: The banks faced difficulties while unwinding their arbitrage positions because of the mark-to-market losses which would have been incurred. Corporate houses did not have much liberty in terms of NDF markets.
Broader Regulatory Tightening
The RBI’s restrictions were not limited to the ban on the NDF. This policy was a part of an extensive package of policies, which included:
- A limit of $100 million cap on banks’ net open positions in the rupee, This had the effect of severely restricting the capacity of the licensed dealers to take directional positions on the currency market, reducing their exposure to any volatility in the process.
- Prohibition on rebooking cancelled derivative contracts, a move intended to prevent market players from continuously buying and selling based on short-term fluctuations in the exchange rates.
- Restrictions on Foreign exchange derivative transactions with related parties means to prevent the arbitrage through the use of intra-group entities which would allow circumvention of the regulatory caps on arbitrage activities.
Together, these steps can be seen as part of a well-thought-out approach by the Reserve Bank of India that was designed to foster discipline in the foreign exchange derivatives market. Through such an approach, it aimed to deal with both direct and indirect means of speculation.
Subsequent Relaxation: A Calibrated Approach
On April 20, 2026, the RBI partially lifted the above-mentioned restriction in order to enable banks to issue NDFs and rebalance their exposure. However, this action does not mean returning to previous practices. Banks will maintain a high level of prudence issuing NDFs due to uncertainties about regulatory parameters and risks of further restrictions.
The phased approach used by RBI implies that the regulator is taking into account changes in market dynamics and will make further decisions on basis of analysis and data collected. Thus, it can be argued that RBI intends to maintain flexibility in its actions so that it could quickly respond to new threats and risks associated with market activities. In this context, one should expect a conservative approach among market participants, who will have to pay special attention to compliance issues.
Broader Implications for India’s FX Market
- Shift to Onshore Markets: The steps taken by RBI signify the need to hedge and gain price information from onshore forex markets, thereby reducing reliance on NDF markets overseas.
- Efficient Regulatory Framework: This signifies that the RBI is prepared to take unusual and quick actions to ensure stability in the financial system, even when it means disrupting the markets in the short run.
- Corporate Treasury Implications: Corporate houses shall be compelled to reassess their hedging strategy, concentrate on managing their hedging approach based on actual exposures.
- Global Investor Sentiment: Although such measures might limit the liquidity in the market, they will certainly be a good indicator of the regulatory approach that can build confidence among foreign investors.
Critical Analysis: Balancing Stability and Market Freedom
The action taken by RBI did succeed in achieving its intended purpose of stabilizing the currency, important considerations need to be made concerning regulatory efficiency.
On one side of the spectrum, it helped stop speculation and bring discipline back to the foreign exchange market. However, it reduced access to hedging tools which can increase costs for corporations with genuine hedging needs. There is also concern that the use of administrative measures instead of market measures might have consequences for the development of the Indian derivatives market in the future.
AMLEGALS Remarks
The RBI’s recent move to prevent banks from providing NDF contracts to corporates is a significant development in India’s foreign exchange regulatory framework in India. This action reflects the interventionist approach adopted by the RBI in managing of the foreign exchange markets in India.
Although the decision was prompted by the need to address speculation and rupee devaluation in the foreign exchange markets, there are other factors that need to be considered in evaluating the implications of this development for the Indian economy. The increasing role of transparency and discipline in the regulation of the foreign exchange markets in India has become evident.
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