Forward premia up; hedging, borrowing costs rise

The forward premium for foreign exchange rose sharply by 83-160 basis points (100 bps is one per cent) across the spectrum, raising hedging costs for importers.

It will also push up the borrowing costs for companies with external repayment obligations.

The rise was after the Reserve Bank of India took further steps to tighten liquidity.

The forward exchange rate (also referred to as forward rate or forward price) is the rate at which a bank agrees to exchange one currency for another at a future date when it enters into a forward contract with an investor.

A forward premium is the spread between the current exchange rate and the higher level used in forward currency exchange deals. The one-month premium moved up to by 160 bps to 10.04 per cent. For one year, the premium was 83 bps, to 9.78 per cent. A premium is the market's indication that the current domestic exchange rate will appreciate.

Treasury executives said one fallout of a high forward premium was to make it more unattractive for exporters to hold on to foreign exchange and to move them to bring the money back home.

With a series of steps by RBI to curb speculation and liquidity in the domestic market, the rupee is expected to rise in the near term. If exporters hold on foreign exchange for more time, they run the risk of getting less for a dollar, they said.

A treasury head with large public sector bank said the forward rates had hardened sharply, tracking RBI measures, which not only raised borrowing costs but also curbed liquidity in the domestic market.

The premium is also linked to interest rate trends.

The treasury head of a foreign bank said the hardening in premium over recent days had more to do with interest rate differentials than the liquidity aspects.