High forward premia leaves exporters with room to hedge

A rising rupee being accompanied by high premium on the dollar in the forward market has left a considerable room for IT companies and other export-oriented industries (EOIs) to hedge their positions sufficiently.

Even as the local currency has risen by around 100 paise over a fortnight, the dollar continues to quote at significantly higher premia in the forward market. However, the forward rates are indicative of the underlying tightness in the local money market rather than a bearish view on the rupee. The outlook may change if exporters rush in to sell in the forward market to take advantage of the high dollar value.

The month of March saw the banking system go through a severe liquidity crunch on account of advance tax outflows, additional bond issuances made by RBI under the market stabilisation scheme and year-end pressures. Tight liquidity conditions have forced several banks and other players to sell dollars in order to generate rupee-funds, so that they could tide over the crisis, without seeking much recourse to the inter-bank call money market where rates spiralled to close to 80% levels.

The loads of sell/buy swaps that these players entered into caused forward premiums to have zoomed in the immediate short term as players rushed in to cover their short-positions. Going forward, several exporters, especially the players in lower rungs are expected to enter into similar forward contracts.

Now, it’s almost a week into April and the three-month forwards are still running at 44 indicating that IT and other export-oriented companies have had enough time to hedge themselves to a great extent. This would be true, at least, for the first quarter of the coming fiscal, indicating no impact on the bottomline on account of rupee appreciation.

The three-month forward premium in paise terms is currently quoting at 80 paise over and above the spot rupee trading at 42.90 vis-a-vis the greenback. No doubt this has declined over the previous few days, but it still continues to remain high, given the current situation.

According to a senior treasury official, the difference in the dollar-rupee level being reflected in the spot and forwards market could also be an outcome of the expectation that the rising rupee could only be a short-term phenomenon. On the other hand, the looming uncertainty over inflation numbers and the argument whether a stronger rupee alone is sufficient to control inflation over the longer-term is also reflected in the aberrations seen.

The other unique thing is that when compared to Europe and the US, it is evident that India is actually moving in a reverse direction. While the Fed is most likely to announce a downward revision in interest rates going forward, and the European Central Bank may also follow suit, India is on the reverse trajectory, where rates are expected to rise further.

A senior treasury manager with a private sector bank explained that the rupee is expected to remain choppy and volatile in the spot market, forwards depend on a different set of parameters such as corporate demand for dollars, fund flows expected to come in etc.

Premiums are a hedge against the volatile behaviour of the rupee. 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.