Dollar-rupee forward premia lowest since 2011 as US-India rate gap shrinks

Indian currency’s recovery since US CPI leads to reversal of onshore-offshore arbitrage.

In a reflection of the narrowing interest rate differentials between the United States (US) and India, one-year dollar-rupee forward premium rates have declined to their lowest levels in 11 years, analysts said.

The plunge in forward premia, which benefits importers looking to hedge their currency exposure, has also been brought about by the reversal of an arbitrage opportunity that had sprung up in the previous month, analysts said.
On Friday, the one-year onshore forward premium rate was at 2.19 per cent, sharply lower than 2.40 percent at the end of the previous month, Bloomberg data showed. The forward premium rate represents the interest rate differential between Indian and US bond yields. The rate differential has been narrowing as the pace of the Federal Reserve’s rate hikes have outstripped those of the RBI. In 2022, the Fed has hiked rates by 375 basis points, while the RBI has tightened policy by 190 bps.
Moreover, while the Fed is widely expected to raise rates by 50 bps again in December, analysts are uncertain as to whether the Indian central bank will hike rates by a similar magnitude early next month.

“The forward premium is at the lowest point since December 2011. It is primarily because of the interest rate convergence. The US rates have outperformed,” Anindya Banerjee, VP, currency derivatives & interest rate derivatives at Kotak Securities said.
What has also contributed to the easing of dollar-rupee forward premia is the trajectory of the rupee since November 11, which was when data showed a larger-than-expected decline in the US inflation. With the data sparking hopes of the Fed slowing down the pace of future rate hikes – the last four US rate hikes have each been of 75 bps – the dollar index has lost ground, leading to appreciation in the rupee.

On November 11, the rupee gained exactly 100 paise versus the greenback, settling at 80.81 per dollar.
The domestic currency has significantly recovered ground from the record intraday low of 83.29 per US dollar on October 20. The rebound in the rupee has resulted in the reversal of a lucrative arbitrage opportunity that existed between onshore and offshore premia. This has in turn, contributed to the recent decline in forward premium rates. “About a month ago, the dollar was very well bid, and at that time the dollar/rupee pair moved to 83 levels.

Everybody was a buyer of the dollar in the market. So, the offshore premia for one year were 75 paise more than the onshore. So, people sold dollars there and bought here,” Anil Kumar Bhansali, head of treasury at Finrex Treasury Advisors said. “After the dollar/rupee started coming down from the 83 levels, the premia started coming down. Onshore to offshore for one year came down to 30-40 paise, which caused people to reverse this trade.

It’s also because the view on the depreciation has changed. If the rupee had gone to 85, traders would not have done this reversal and the premiums would have moved higher,” he said. While the fall in forward premium rates bodes well for importers by bringing down their hedging costs, exporters looking to sell dollars stand to lose.

“It’s good for importers because importers are hedging for the near term, they don’t hedge for the long-term.
Nobody likes to pay a big amount of premium. So, maybe they were hedging initially for the first two months. But then the premia shot up to 3.5-4.00%. Now that it has come down, they can hedge for two-three months. For exporters, of course, it is not good, they will only have to sell for the very near-term,” Bhansali said.

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