MUMBAI: Hedging dollar interest payments on foreign currency non-resident (bank), or FCNR(B), deposits is set to become costlier for banks, with the Reserve Bank of India (RBI) requiring the lenders to set aside cash equivalent to 20 per cent of the exposure under its Foreign Exchange Risk Reserve (FERR) framework introduced earlier this month.
The 12-month dollar-rupee forward premium has risen by 102 basis points in October so far, increasing the cost of hedging future dollar payments. The premium, which reflects the difference between forward and spot exchange rates, rose to 4.38 per cent on Thursday from 3.36 per cent at the end of September.
Banks have mobilised a large pool of FCNR(B) deposits through the RBI’s special swap window. Inflows exceeded expectations — reaching $133 billion against the earlier estimate of $75 billion-$100 billion — prompting the RBI to close the window a month earlier than scheduled, on August 31. The swap window covers only the principal of these deposits, leaving banks to arrange hedging for the interest payments themselves.
Banks are assessing how best to hedge the interest component of their FCNR(B) dollar exposure. Some have used forward contracts and other derivative transactions, while others have not fully hedged their exposure. Banks could choose to retain some unhedged positions if they expect the rupee to remain around current levels, though their decisions will depend on their outlook for the currency. “Banks with a strong overseas presence might have it easier, but nobody would like to keep such a large amount of unhedged position,” said a senior executive at a state-owned bank.
The RBI introduced FERR to curb volatility in the rupee. Under the framework, the reserve is equivalent to 20 per cent of the rupee value of the notional amount of eligible foreign exchange derivative contracts. It applies to specified rupee-linked contracts where users buy foreign currency to hedge current account transactions and the notional value exceeds $2 million. Banks must also maintain the reserve for eligible contracts undertaken to hedge currency risks on their own assets and liabilities.
Under the revised rules, transactions undertaken from October 12 are subject to the new guidelines, whether they involve fresh contracts or rollovers. The RBI has also restricted the rebooking of cancelled foreign exchange derivative contracts.
The reserve adds to hedging costs because funds parked with the RBI do not earn interest. Banks must maintain the reserve daily for each eligible transaction and keep it in place until a day after the derivative contract terminates.
The increase in forward premiums comes as banks and customers adjust their positions to the new rules. Market participants expect the rupee to weaken over the longer term despite its recent recovery, prompting importers to use current levels to lock in forward dollar purchases.
“It is a problem that banks are trying to figure out. Some large banks with natural hedging went in very aggressively for deposits, but others like us did not. A lot depends on how the rupee moves,” said a senior banker at a private bank.
Banks are advising some customers to book shorter-dated forward contracts of two to three months rather than hedge their entire exposure over longer periods. The approach reflects hopes that market conditions will stabilise and the restrictions may be reviewed in the coming months, market participants said. However, there is no certainty that the RBI will withdraw the measures.
Source: Business Standard
