Warning On Unhedged Forex Borrowings

RBI ANNUAL REPORT FOR 2002-03

The Reserve Bank of India has warned banks against unhedged lending in foreign currency since exchange risk could easily turned into credit risk, especially when the exchange rate movement becomes adverse.

In its annual report (2003-04), the RBI has called up the banks to put in place a system for monitoring such unhedged external liabilities.

The observation has been made against the backdrop of recent trends in the exchange rate and interest rate movements fuelling greater demand by corporates for foreign currency loans from Indian banks.

At the same time, considerable flexibility has been given to the corporates over a period of time to hedge their foreign exchange exposure in the market.

With the depreciation of dollar to all major currencies including Indian rupee, a significant portion of the corporate prefer to keep their foreign currency commitments remain unhedgedon the basis of the market perception.

The RBI has stated that such open positions could potentially have an impact on their overall financial position in case of unexpected developments.

It was also observed that although forward rates reflect the differential between domestic and foreign interest rates, in the recent period downward movement in forward premia have been primarily driven by the anticipation of further appreciation of the spot rupee exchange rate against the US dollar.

This phenomenon has been further strengthened by a rush to borrow foreign exchange overseas at relatively low interest rates and convert it into rupee assets which attract a relatively higher rate of return.