Far Forward Liquidity Up On Easy Premia

The easing of the premium on forward dollars has added much needed liquidity to the far forwards market.

This market, which was characterised largely by sellers, has of late witnessed increased entry by buyers as the one-year dollar is now cheaper at Rs 37.5 as compared with Rs 38.5 earlier.

This development has been increasingly observed over the last few weeks. Bankers say it follows lower dollar premiums as well as increased recourse by firms to foreign currency borrowings, including FCNR(B) loans and external commercial borrowings. Earlier, corporates would only sell one-year dollars. At a premium of 7.5 per cent, they would get almost Rs 38.50 to the dollar. However, corporates wishing to buy one-year dollars found the price high.

 

Now, with the cost of the one-year dollar at around 4.8 per cent, corporates, particularly those without in-house treasury management function, are preferring to book the one-year contract rather than follow the standard practice of booking for six months and then renewing at the end of the period. Dealers said it makes sense for firms going in for foreign currency borrowings to hedge and protect themselves against the exchange rate risk.

By booking the one-year forward, the corporate enjoys a substantial reduction in his cost of funds. Say, for instance, a corporate borrows at Libor of 6 per cent plus a spread of 150 basis points, that is 7.5 per cent points.

For a six-month cover, he would pay 4.7 per cent which is the forward premium six month annualised. His cost would be 12.2 per cent. However, at the end of six months, he will have to renew the contract. If the premiums are at a higher level than the current levels, he winds up paying more. However, if he takes the one-year cover, his cost would work out to 12.3 per cent as the one-year premium is 4.8 per cent. This is lower than the present prime lending rate of 14 per cent.

On account of the increased liquidity, the spread between the far forward premiums has come down from 20 paise to 10 paise now. Most of the deals are being struck by foreign banks. The deals being struck are in the range of $100 to $200 million dollars.