India Tightens Currency Hedge Rules for Foreigners to Buoy Rupee

India’s central bank said foreign funds that have sold offshore derivatives of local stocks and bonds must get their customers’ approval to hedge currency risk on the underlying onshore investments. The rupee rebounded.

Money managers, who have issued so-called participatory notes to investors or hedge funds not registered in India, need to provide a mandate from them stating an intention to hedge, the Reserve Bank of India said in a statement on its website today. Banks in India executing currency trades on behalf of overseas funds need to verify such mandates, the RBI said.

India is tightening rules on foreigners’ currency trades to curb exchange-rate speculation, according to UBS AG, after the rupee plunged 10 percent since March and slid to a record 61.2125 per dollar on July 8. Inflows via participatory notes accounted for 11 percent of the 13.5 trillion rupees ($224 billion) invested in Indian shares, debt and derivatives as of June 30, data from the market regulator show.

“The RBI is looking to restrict speculative trading by demanding proof that investors are only hedging an underlying asset,” Manik Narain, a strategist at UBS in London, said in a phone interview today. “In the very short term, the ruling will flush out short-rupee positions.”

The rupee weakened 0.2 percent from yesterday to 60.4500 per dollar at the close, after earlier falling as much as 0.9 percent. The RBI restricted trading in currency derivatives and tightened cash supply last month month to support the rupee.

Pressure on the rupee to weaken will persist because of India’s current-account deficit and a slowdown in investment inflows, according to Narain. The shortfall widened to an unprecedented 4.8 percent of gross domestic product in the year ended March 31. International investors pulled $3 billion from local stocks and bonds in July, according to exchange data.

One-month implied volatility in the rupee, a gauge of expected moves in the exchange rate used to price options, surged 129 basis points last month, or 1.29 percentage points, to 13.80 percent. That’s the highest in Asia.

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