Currency hedging gets cheaper as forward premia take a dip

Hedging currency risks could have never gotten this cheap in recent times and importers are making the best of the situation. Premia on forward contracts have been on the decline, given the ample cash flows in the system and falling interest rates in the money market. Importers are now making a beeline for booking dollar-denominated forward contracts, whose premia have almost halved in a month’s time.

For the past few days, the yield on the one-month contract has actually dipped below 1% levels. The premium on the three-month contract, which is the most commonly-used one, has dipped to 1.77% from around 4%, a month ago.

Buyers of foreign currency pay a premium or discount, depending on the view they take on the future course of the currency, in order to hedge the risks associated with the price of the currency. A view that the rupee will weaken further implies that the buyer will pay a premium to avoid losses on paying higher amount for the currency.

Treasury officials point out that this is largely due to the abundant cash inflows into the system, which are propelling rates to head southward. Call rates are currently below 1% levels while yields on certificates of deposits and commercial papers have dipped to as low as 7-8% on the lower end, from over 10% levels in March and April. Correspondingly, yields on government bonds have also eased substantially in the past one month, from over 8.40% levels to around 8.02% levels on Wednesday.

The rupee closed at a nine-year high of 40.45 levels against the dollar, buoyed by selling of the greenback by multinational banks. Given that general price levels have also eased from over 6% levels to less than 4.50%, market players anticipate that the central bank may resume intervention in the forex market and support the rupee at 40.50 levels. For exporters, this spells good news as the dollar would not grow significantly weaker from the current levels. This leaves them with a better option of keeping their dollar exposures open.

Global Trade Finance’s treasury head Milind Nare said, “Importers need to make full use of this opportunity to cover their dollar positions since their liabilities are denominated in the dollar.” Although importers began to hedge their dollar positions a week ago, the activity has picked up on heightened interest after the closing of the first quarter.

This is because most of the corporates consider building up fresh positions in the new quarter only. Standard Chartered Bank’s head of forex and derivatives trading for South Asia Agam Gupta explained, “Falling premia are largely due to a pure money market phenomenon. In fact, premia should have ideally come off to a greater extent. However, further dip in the premia has been curbed by importers who stepped in to cover their positions.”

Mr Gupta added that call rates are likely to be lower than 6% going forward. And this implies that premia would be trading steady but with a downward bias. Treasury officials feel that the current situation is likely to persist, unless the central bank announces any moves to drain the excess liquidity from within the system.