Cost of covering currency risk surges since December

Forward premia for shorter maturity contracts, the most popular segment, have spiked as much as 118 basis points, potentially acting as a hindrance for local companies seeking to borrow overseas.

One basis point is 0.01%.

The three-month onshore implied forward yield was at 4.83% Tuesday versus 3.65% on December 8 when the central bank announced its last bi-monthly policy, Bloomberg data show. On January 31, it soared as much as 133 basis points to 4.98%.

Higher yields or premia inflate borrowing or hedging costs and bump up risks of exchange-rate fluctuations, especially when the currency in the borrowing market appreciates steeply against the monetary unit of the revenue-generating market.

“This is a reflection of tighter liquidity conditions immediately after the RBI’s December policy when VRRR was used to cut surplus cash in the system,” said Anindya Banerjee, currency analyst at Kotak Securities.

“Globally, central banks are winding up ultra-loose monetary policy, which in turn is weighing on the cost of covering currency risks,” he said.

On December 8, the surplus cash in the system was Rs 8.26 lakh crore versus Rs 6.45 lakh crore now, show data from the central bank.

“Any rise in forward premium in the shorter maturity contracts will likely cut the cost advantage for local borrowers tapping overseas funds,” said Kunal Sodhani, associate vice president at Shinhan Bank India. “The cost of money is rising, which is also weighing on forward premia in the currency market with dwindling surplus funds.”

Reliance Industries, State Bank of India, JSW Infrastructure and Shriram Transport sold a record $6 billion worth of bonds to international investors in the first two weeks of January. Companies hedge their overseas liabilities depending on the usage of funds.

“Importers are not comfortable to cover their whole outward payments as hedging costs have gone up in the short term…,” said Abhishek Goenka, founder and CEO of IFA Global. “Markets across the world are adjusting to central banks’ measures of sucking out excess liquidity from the system, which is bound to trigger volatility in the currency market.”

“Companies are buying time before they take new bets on the exchange rate,” he said.

The one-month onshore forwards premium rose 54 basis points to 3.83%. Premium on the six-month contract rose eight basis points, according to the Bloomberg gauges.

“Importers are now shying away from taking hedges due to the surge in the shorter maturity forwards premium,” said Banerjee.

The forward premium has gone down for the 12-month contract by about 13 basis points. The yield is at 4.46% compared with 4.59% in the second week of December last year.

Earlier, the RBI used to buy dollars to arrest the rupee’s abrupt rise, which infused rupee liquidity into the system. To nullify its effect on liquidity it carried out sell-buy swap transactions in the forwards market, a move which raised forwards premia.

“This has now stopped as the central bank has not been doing such swaps aggressively in recent times,” said Goenka.