RBI Circular Oct 2026: NDDC Rules & Foreign Exchange Risk Reserve

What Happened?

On October 12, 2026, the Reserve Bank of India (RBI) issued Circular No. 27 under the A.P. (DIR Series), significantly tightening regulations on non-deliverable derivative contracts (NDDCs) involving Indian Rupee. The key changes are:

• NDDCs involving INR can now only be offered to non-residents for hedging purposes (previously allowed without restriction)
• Authorized Dealers must maintain a 20% Foreign Exchange Risk Reserve (FERR) on forex derivative contracts
• FERR must be deposited daily in cash with RBI until contract termination
• These rules apply to all contracts entered after October 12, 2026

This circular amends the Master Direction on Risk Management and Inter-Bank Dealings originally issued on July 5, 2016.

Background & Legal Context

To understand this circular, you need to know the legal framework:

• FEMA 1999 Authority: This circular is issued under Sections 10(4) and 11(1) of the Foreign Exchange Management Act, 1999, which gives RBI power to regulate foreign exchange transactions
• RBI Act 1934: Section 45W of the RBI Act, 1934 also empowers RBI to issue these directions
• Non-Deliverable Derivatives (NDDCs): These are forex contracts settled in a third currency (usually USD) rather than actual delivery of INR. They are commonly used by non-residents who cannot access deliverable forex markets in India
• Who are Authorized Dealers? Category-I banks (with IFSC Banking Units) and Standalone Primary Dealers (Category-III) can offer these products

Under the Income Tax Act 2025, foreign exchange derivative contracts are treated as capital assets or business income depending on the nature of the transaction. The taxation implications differ based on whether the transaction is for hedging (revenue receipt/loss) or speculation (capital gains/losses).

For AY 2025-26 and AY 2026-27, businesses engaging in forex derivatives must maintain proper documentation proving the hedging nature of transactions. This RBI circular now makes it mandatory that NDDCs involving INR are used only for genuine hedging—making tax compliance easier and reducing scrutiny risk.

What Does This Mean for You?

For Banks and Authorized Dealers:

• Restricted Product Offering: You can no longer offer NDDCs to non-residents for speculative or arbitrage purposes. Only hedging-related contracts are permitted. This narrows your client base and revenue potential.
• FERR Requirement—Cash Outflow: The 20% Foreign Exchange Risk Reserve requirement is a significant cash management burden. If an Authorized Dealer offers a $10 million NDDC contract, it must deposit ₹1.67 crore (20% of INR equivalent at ~83/USD) with RBI in cash daily. This impacts liquidity and increases operational costs.
• Risk Management: The FERR serves as a risk mitigation measure—ensuring banks have sufficient capital cushion against adverse forex movements. Daily maintenance (until contract termination) means constant reconciliation and reporting requirements.

For Non-Resident Users (Foreign Companies/Individuals):

• Hedging Only—No Speculation: If you are a non-resident and were using NDDCs for profit-taking or speculative positions, this is no longer allowed. You can only use these contracts to hedge actual business exposures (e.g., a foreign exporter with INR receivables can hedge currency risk).
• Documentation Imperative: You must maintain robust documentary evidence of the underlying hedged exposure—invoices, contracts, purchase orders, etc. RBI will monitor compliance.

For Indian Corporates (Exporters/Importers):

• Clearer Tax Treatment: With NDDCs now restricted to hedging only, the tax classification is simplified. Under the Income Tax Act 2025, hedging gains/losses are typically treated as revenue in nature and added to business income (not capital gains), taxed at normal rates.
• Better Documentation Trail: The RBI's mandatory hedging-only rule supports your tax defense during IT audits. You have regulatory backing that your forex derivative was a legitimate business hedge.
• Assessment Year Impact: For AY 2025-26 onwards, auditors and tax officers will expect corporates to have complied with this circular. Non-compliance = both regulatory penalty and disallowance of forex losses under IT Act.

For the General Taxpayer:

• If you invest in forex products through banks, ensure they are RBI-compliant. Non-compliant products may attract income tax scrutiny and GST complications.

What Should You Do Now?

Immediate Action Items:

• Audit Existing Contracts: If you are an Authorized Dealer, review all NDDCs involving INR. Contracts entered before October 12, 2026 are grandfathered (old rules apply). Contracts from October 12, 2026 onwards must comply with the new 20% FERR requirement.
• Proof of Hedging Intent: Document the hedging purpose of every NDDC. This includes:
  • Underlying business transaction details
  • Timing correlation between hedge and exposure
  • Ratio of hedge to exposure (should be ≤100%)
• Liquidity Planning: Authorized Dealers must reserve 20% cash daily. Restructure treasury operations to accommodate this.
• Client Communication: If you offer NDDCs, inform non-resident clients that speculative contracts are no longer available. Reclassify existing contracts or wind them down if they don't meet hedging criteria.
• Compliance Calendar: Mark October 12, 2026 as the implementation date. Conduct internal training on the new FERR calculation and daily reporting to RBI.
• Tax Provision: Under the Income Tax Act 2025, Section 40(a) and Section 43 may apply to forex derivatives. Ensure proper accounting classification in profit & loss statements for AY 2026-27.

Recommended Documentation for Audits:

• Board resolutions approving forex hedging policy
• Executed hedging contracts with clear "hedging purpose" clause
• Monthly reconciliation of hedged exposures vs. hedge ratio
• RBI compliance certifications and FERR deposit confirmations

Key Takeaways

• Hedging-Only Mandate: NDDCs involving INR are now restricted to genuine hedging purposes. Speculative usage by non-residents is prohibited effective October 12, 2026.
• 20% FERR Requirement: Authorized Dealers must deposit and maintain daily cash reserves equal to 20% of the INR notional value of each forex derivative contract with RBI until termination.
• Tax Clarity: This regulatory shift strengthens the tax position of businesses using forex derivatives for hedging, as the income tax treatment is now aligned with regulatory intent (revenue/loss, not capital).
• Grandfathering of Old Contracts: Contracts entered before October 12, 2026 are exempt from the new FERR rule. Only new contracts attract the 20% reserve requirement.
• Compliance for AY 2026-27: Taxpayers and banks must ensure full compliance by assessment year 2026-27, or face disallowance of losses, penalties under FEMA, and potential prosecution under Section 132 IT Act (search and seizure).

Practical Takeaway: This circular is pro-regulation and anti-speculation. It protects the Indian rupee from excessive derivative-driven volatility. For legitimate hedgers, compliance is straightforward—maintain proof of underlying exposure. For speculators, the door is closing. Authorized Dealers face higher capital requirements but gain clarity on permissible business.

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