Forward Premiums Cranked Up

The Reserve Bank of India (RBI) has induced a firming up of the forward dollar premiums to discourage unnecessary importer-buying to ease pressure in the forward segment of the foreign exchange market, a central bank statement said yesterday.

The RBI hiked its prescribed cash reserve ratio (CRR) for banks to 11 per cent from 10 per cent effective August 29 effectively reducing the liquidity in the system by Rs 5200 crore. It further raised the interest rate on its fixed rate securities repurchase (repo) agreement to eight per cent from five per cent.

The moves will result in near-term inter-bank rupee interest rates firming up which will result in forward dollar premiums also rising.

The central bank has also attempted to limit corporates' speculative tendencies by restricting flexibility with regards to booking forward dollar contracts.

It has insisted that corporates book the spot and forward leg of a forward contract simultaneously. It has also barred re-booking of cancelled forward contracts for trade and non-trade purposes.

The corporates measures were complemented by RBI activity in the forward market through sell-buy swaps for September and October maturities which accentuated the forward dollar's rise. Near term premiums shot up, and the one month premium, for instance, closed at 19.04 per cent compared to 9.83 per cent on Wednesday.

A forward contract booked by a corporate, usually has a spot and forward leg. In 1993, the RBI permitted corporates to book the two legs separately so as to get the best rates and minimise their cost of cover.

However, under volatile conditions, larger players would book only the spot leg of the contract without booking the forward in order to take advantage of movements in the rate. This generated demand for spot dollars which caused the rupee to weaken. If the rates moved in their favour, they would cancel the contract fuelling volatility.

The RBI measures would reduce a corporate's tendency to book the forward contract even if it had a genuine underlying exposure unless it was absolutely necessary, dealers said. "With premiums ruling at such high levels, a corporate would think twice before booking a contract," a dealer said.

"As a temporary measure, it may be effective by discouraging them from buying premiums at such unrealistic levels. It is obvious that the premiums will come down and it would be better to wait," a corporate treasurer said.