FCNR(B) interest bill to keep dollar hedging costs high
As a multibillion-dollar FCNR(B) interest bill escalates, Indian banks grapple with increased dollar hedging expenses. Recently, the Reserve Bank of India mandated new reserve prerequisites for forex derivatives, compounding the challenges for ban...
At an average interest rate of 6.5-7.0%, the annual interest outgo on these deposits is estimated at $8.6 billion to $9.3 billion.
Mumbai: A multibillion-dollar FCNR(B) interest bill, coupled with the Reserve Bank of India's new reserve requirement on forex derivatives, is likely to keep dollar hedging costlier for Indian banks, treasury executives said.
While the RBI provided a hedging facility for the $133 billion raised for three to five years under the special window opened for mobilising foreign currency deposits, banks must bear the currency risk on interest payments to non-resident depositors.
At an average interest rate of 6.5-7.0%, the annual interest outgo on these deposits is estimated at $8.6 billion to $9.3 billion. At least half of this amount remains unhedged, according to treasury heads at six banks ET spoke with, leaving lenders with more than $4 billion in dollar exposure to manage annually.
"The interest on FCNR(B) deposits is not covered by the window. Banks have to buy those dollars forward themselves, year after year, in the open market," said Anindya Banerjee, head of currency research at Kotak Securities.
"A forward premium is simply the extra price one pays today to lock in dollars for delivery later. When the entire banking system is buying dollars forward for the same reason, and there are not enough natural sellers, that extra price goes up," Banerjee said.
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Adding to the pressure is the RBI's new reserve requirement on banks' derivative positions. Introduced on October 10, the foreign exchange risk reserve (FERR) requires banks to maintain a cash reserve equivalent to 20% of the rupee value of eligible foreign-exchange derivative contracts.
FERR makes it more expensive for banks to offer certain forward-dollar hedges because they must lock away cash against the contracts. Banks may pass on part of this additional cost to customers, putting further pressure on forward premia. The one-month and one-year forward premia were 2.50% and 2.78%, respectively, in early August. They surged to 8.50% and 4.85% by mid-October before easing to 3.83% and 3.91% by November 6, reflecting near-term dollar demand.
A treasury head from a private bank said most banks had not put a hedging strategy in place as they were still assessing how best to manage this exposure. FERR in October added another layer of cost, making banks more cautious about locking in dollar liabilities over longer tenures. He explained that for now, the exposure was managed as it accrued, using short-term contracts that could be rolled over rather than hedging the entire interest obligation upfront. The reliance on short-term, rollover, contracts means banks will repeatedly return to the forward market as their interest liabilities accrue, sustaining demand for dollars instead of eliminating the exposure through an upfront hedge.
Foreign banks, however, appear more comfortable carrying unhedged positions because they receive a steady stream of dollars from clients.
A treasury executive from a foreign bank said some banks might hedge in the coming days as the rupee appreciated.
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The rupee staged a sharp recovery during the week, appreciating nearly 1.2% to close at 93.90 per dollar on Friday, its strongest level in more than six months.
Some midsize banks, meanwhile, hedged the bulk of their dollar exposure after costs fell within their internal thresholds.
