Foreign exchange hedging cost rises after RBI dollar-rupee swap plan

One-year dollar-rupee forward premia closes at 4.19%

The foreign exchange hedging cost, which plunged after the central bank delivered a ‘super dovish’ monetary policy on February 10, changed direction after the announcement of a $5-billion dollar-rupee sell-buy swap auction on Monday. The one-year dollar-rupee forward premia shot up almost 18 bps after the announcement, but moderated by the end of the trading session on Wednesday, closing at 4.19 per cent.

“The jump in USDINR forward premia after RBI’s sell/buy USDINR swap auction announcement, led to long-term forward premia rise,” said Amit Pabari, MD, CR Forex.

“The main action was seen in 6-12 months and 12-24 months’ window. This attracted exporters to sell long-dated forwards, taking advantage of the higher forward premia. It also attracted some other players interested in carrying out trade of USDINR. This move did impact importers, but relatively small, since importers usually do not hedge beyond three months, as they have to pay forward premia upfront, unlike exporters who receive the premia,” he said.

Forward premiums are essentially interest rate differentials between two currencies and a change in forward premiums is due to movement of interest rate of the currencies. Increase in forward premium reflects higher hedging cost for the companies.

Analysts said the sell-buy dollar rupee swap — the auction would be conducted on March 8 — would be used tactically by the RBI as one of the tools to smoothen banking system liquidity.

“This tool, if used more often, could pressure the forward premia and improve INR carry and returns,” Madhavi Puri, lead economists Emkay Global said after the RBI swap announcement.

Besides, the swap auction was also aimed at managing the huge inflows expected ahead of the initial public offering of Life Insurance Corporation (LIC) of India and other firms in March. The inflows are expected in the range of $15 billion to $18 billion.

The rupee also gained against the dollar on Wednesday like many of the emerging market Asian currencies as investors felt sanctions against Russia by would be limited. The rupee fell sharply against the dollar on Tuesday after the Russia-Ukraine crisis deepened.

According to Pabari, one of the reasons for the reversal in dollar-rupee spot rates is reversal of risk sentiments, as there is hope that the situation between Russia-Ukraine will not escalate to a war.

The rupee closed at 74.57/$ on Wednesday as compared to its previous close of 74.88.

The relief for the domestic unit could be short-lived if Russia-Ukraine tensions escalate, in which case the rupee could slip below 75/$ again, analysts said.

“SPOT USDINR pair continues to witness volatile sessions as tensions between Russia and Ukraine continue to dominate sentiments across global markets,” Emkay Global said in a note.

“An escalation of the current situation will trigger a rally in USDINR pair towards 75.25 and targets of 75.72 will open up above this. Until then, we expect market to absorb the news flows in a range between 75.25-74.40,” the note added.