RBI's rupee management undermines hedging push

Rush of foreign money is forcing RBI to buy dollars in spot market and sell them in the forward market

The Reserve Bank of India's intervention to temper the rupee's rise is inflating foreign exchange hedging costs, impeding its own efforts to bolster Corporate India's defences against potential currency turbulence.

For long, one of the biggest concerns for the RBI has been the risk of a destabilising outflow of funds as the US Federal Reserve edges closer towards raising interest rates from historic lows.

However, it is the rush of foreign money coming into Asia's third-biggest economy - about $14.3 billion has flowed into debt and equity markets this year - that is putting the central bank in a tight spot, forcing it to buy dollars in the spot market and sell them in the forward market.

The effect of removing excess rupees from the system as the RBI sterilises the inflationary effect of money supply has further driven up rupee interest rates above dollar rates. This means banks and companies have to pay more rupees to hedge their dollar liabilities in the futures markets.

Ashish Vaidya, head of trading, asset liability management at DBS in Mumbai, said the RBI has to walk a fine line as it looks to ensure price stability while taking the upward pressure off the rupee from capital inflows.

"The RBI is buying dollars in the spot market and then paying forward to remove the surge of rupee liquidity, as it has to maintain price stability," he said.

Corporates must now pay upwards of 7.6% to buy dollars and sell rupees to meet future obligations. The six-month forward premium on the dollar versus the rupee has risen by around 35 basis points so far in 2015.

"The implication of higher forward dollar/rupee premium is importers are hedging less than they should, which is a risk to the banking system," said Anindya Das Gupta, managing director, head of trading at Barclays in India - precisely the kind of risk the RBI wants to minimise.

Underscoring the perils of inadequate hedging, the rupee fell 0.9% intraday on Monday - its steepest slide since Dec 16.

Last October, RBI Deputy Governor H R Khan warned the hedge ratio for overseas loans and foreign convertible debt had halved to around 15% in July-August from the previous fiscal year.

CAPITAL FLOWS

The rupee was the third best performing currency in Asia in the March quarter, rising 0.85% - backed by rising inflows on optimism over economic growth, stable inflation and structural reforms. It has retreated since then and is up around 0.2% so far in 2015.

The robust capital inflows have boosted importers' confidence that any rupee depreciation will be less costly than a hedge, while most exporters have also been lax about hedging on the view the currency will move in a tight band.

"If we hedge, we will lose a lot of money," a senior official at a state-run oil company said, noting the short import payments period.

The stubbornly strong rupee has ramped up RBI's operations in the spot forex market - it bought a net $20 billion in January and February. The central bank has also been swapping rupees for dollars in the forward market, adding $260 million in up to one-year dollar contracts in February. In contrast, the RBI's net dollar holdings in tenors up to one-year fell sharply by $6.49 billion in December.

"We are not going to maintain any particular level for the rupee and so they (firms) have to recognize that they are taking on a big risk," Governor Raghuram Rajan said earlier this month, sounding a warning to firms that aren't hedging their currency exposure.