$127 billion deposits raise new rupee risk as banks face future FX interest bills

MUMBAI: Indian banks have left much of their future interest payments on overseas FX deposits unhedged, creating a source of potential dollar demand that could compound depreciation pressure in a rupee-weakening scenario, five bankers said.

Lenders have raised more than $127 billion in such deposits since the central bank introduced them as part of one-off measures to strengthen India's balance of payments in the face of surging oil ‌prices in June.

Also Read: Record FCNR (B) inflows as banks mobilise $127 bln


While ⁠the ⁠Reserve Bank of India's special swap facility shields banks from FX risk on the deposits' principal amounts, interest payments need ​to be managed by lenders independently.

Foreign banks are largely hedging exposure. Most state-run banks and several private-sector Indian lenders have not, the bankers said.

One banker at a mid-sized state-run lender said their bank had decided not to hedge the interest-payment FX exposure for now, citing the high cost and ​recent comfort provided by the RBI's intervention-driven rupee rally.

"At the ⁠moment, the ‌expectation is that interest payments can be handled via spot dollar purchases ​when needed ​as opposed to locking in protection," the official said.

All five bankers requested ⁠anonymity because they were not authorised to speak to the media. ​The RBI did not immediately respond to an email seeking comment ​about the risk of unhedged interest payments.

COSTLY HEDGES, RUPEE RISKS

It costs banks about 3% a year to hedge FX risk on interest payments for deposits of 3- to 5-year tenors, for which the interest is paid when the deposits mature, rather than periodically, bankers said.

The head of FX trading at a private-sector bank said the cost of hedging is prohibitive, particularly given ‌how recent RBI intervention has made risk-reward on the rupee "asymmetrical."

Also Read: RBI faces about $11 billion bill on foreign deposits plan

Positive developments are more likely to trigger a large rupee rally than negative news is to ​weigh on the ​local currency, he said.

The rupee ⁠this week climbed to a two-month high amid persistent RBI intervention, boosted by greater firepower from the overseas FX deposits, analysts said.

That respite could be tested, however, with Brent crude oil prices again ​approaching $100 a barrel and markets pricing a 60% chance of a rate hike by the U.S. Federal Reserve next week.

With at least half of banks' interest-cost exposure unhedged, renewed rupee weakness could trigger a rush for dollars. A move toward 96-97 per dollar could shift banks' limited inclination to hedge, said a second banker who heads FX trading at a private-sector bank.