MUMBAI: The Reserve Bank of India’s (RBI) efforts to defend the rupee could come at a steep price for importers. Economists and bankers expect the central bank’s latest foreign exchange restrictions to raise hedging costs by 1.1–1.6 percentage points, making it more expensive for companies to protect themselves against currency volatility.
For many corporates, hedging costs have already risen sharply. A treasury official at a large corporate said annual hedging costs had climbed from around 2.5% about 18 months ago to over 4.5% now. The RBI’s latest measures could take the total cost to nearly 6%.
“That is a significant burden that effectively penalises genuine businesses. Without hedging, how do we protect ourselves from forex volatility?” the official asked.
“The foreign exchange risk reserve (FERR) requirement will add to importers’ hedging costs over and above the spot-forward premium, banks’ margins and exchange rate movements. Until the pricing mechanism becomes clearer, importers are likely to adopt a wait-and-watch approach,” said V R C Reddy, head of treasury, Karur Vysya Bank.
He expects overall hedging costs to rise by 1.1–1.5 percentage points, depending on how much of the additional burden banks pass on to customers.
On Saturday, the RBI announced a series of measures to stem the rupee’s slide. These include a ban on rebooking cancelled foreign exchange derivative contracts, a sharp reduction in the limit for derivative trades without underlying exposure from $100 million to $5 million, and stricter documentation requirements for banks.
The most significant move is the introduction of the FERR requirement, a first for India. Under the new rule, banks must maintain a reserve with the RBI equivalent to 20% of the rupee value of the notional amount for each qualifying current account transaction exceeding $2 million.
China’s central bank has previously used a similar mechanism to curb speculative pressure on the yuan.
While banks will bear the direct cost of maintaining these reserves, the burden is unlikely to stop there. Lenders are expected to pass on at least part of the additional cost to customers through wider spreads, less favourable pricing or tighter trading limits.
ANZ Bank said in a note that banks would bear the direct reserve requirement but were likely to pass on or share the opportunity cost with customers.
The impact could be particularly significant for importers, who typically buy dollars forward to protect themselves against a weakening rupee.
Higher costs could prompt companies to reduce their hedge ratios, shorten contract tenures or explore alternative instruments. Some may postpone dollar purchases rather than lock in expensive forward contracts.
“Some importer demand may simply shift from forwards to future spot purchases, leaving the underlying dollar demand and, in turn, the RBI’s intervention burden intact,” Emkay Global said.
The corporate treasury official added companies might have little choice but to lower their hedge ratios or shift to option-based structures. Such strategies could reduce upfront costs but may also provide more limited protection against adverse currency movements.
Kotak Mahindra Bank estimates that average daily foreign currency purchases against the rupee amount to about $3 billion. Since most derivative contracts exceed the $2-million threshold, nearly 80% of daily forward purchase volumes could come under the FERR requirement.
Estimates by ANZ Bank, Emkay Global and Kotak Mahindra Bank suggest that hedging costs could rise by 1.1–1.6 percentage points.
Economists expect the higher costs to dampen hedging activity, potentially easing pressure on forward premiums.
However, this could create another problem for the RBI. Lower hedging activity does not eliminate the underlying demand for dollars. It merely shifts currency risk from the forward market to corporate balance sheets, leaving companies more exposed to further rupee depreciation.
Source: The Financial Express
