Rupee vs Dollar: The Reserve Bank of India (RBI) is constantly trying new measures to reduce pressure on the Indian currency. Whenever the rupee slips to a record low against the dollar, the central bank intervenes in the market. In recent days, the RBI opted for the sell-buy swap route to prevent a sharp fall in the rupee. Under this arrangement, the central bank sells dollars in the spot market and also promises to buy them back at some future date. This strategy was successful to some extent and put a brake on the sharp depreciation of the rupee. But market experts believe that this move has also created an unwanted problem. This bet has led to a huge jump in forward premiums, which has thrown foreign investors off balance.

A new twist in the effort to support the rupee

According to banking experts, the central bank’s objective was to provide strong support to the rupee. But due to the increase in forward premium, it is having the opposite effect. It is now proving costlier than ever for foreign funds to buy rupee-linked assets. The main reason for this is the sudden increase in hedging costs. When foreign investors invest capital in another country, they resort to hedging to protect their money from currency fluctuations.

According to Kunal Sodhani, Head of Treasury, Shinhan Bank India, the increase in forward premium directly increases costs for foreign investors who fully hedge their currency risks. This makes the total return less attractive in rupee terms. The result is that there may be a slight brake on foreign investment coming into the debt and portfolio markets. If we look at the data, the total cost of the one-year dollar-rupee forward premium rose from 7.40 percent to 8.65 percent in less than a month. Although it fell slightly to 8.45 percent on Thursday, it is still too expensive for foreign investors to protect their capital.

Rising costs become a headache for foreign investors

The impact of such an increase in forward premium is not limited to foreign funds, but it is changing the mood of the entire market. Kunal Sodhani says that in the current environment, the most impact is being seen on the method of hedging. When the premium is high, exporters have an incentive to sell their dollars for the future. Conversely, forward hedging becomes very expensive for importers and borrowers.

Demand for dollars in the market is under pressure due to increase in cost of importers. On the other hand, the position of the rupee is also very fragile. The rupee opened strongly at 96.68 in Thursday’s business session. But by afternoon, pressure started to show again as crude oil prices rose. In late trade, the rupee weakened slightly to close at 96.79 per dollar, compared to 96.7750 on Wednesday. The rupee is still very close to its record low of 96.96, which is not easing central bank concerns.

New threat of dollar outflow due to cheap domestic loans

Another startling aspect has come to light in this whole process, which could be a new reason for the dollar to leave the country. Large companies of the country, whose business is also spread abroad, are now preferring to get loans from the Indian market rather than foreign markets. Banking officials say it is becoming cheaper for Indian companies to take loans in rupees within the country and then convert them into dollars to use for overseas operations.

Interest rates in foreign markets have become very high. If a highly rated Indian company takes a three-year loan from abroad, it gets finance at around 5.50 per cent. But when hedging costs of around 3.25 per cent are added, these loans go up to over 9 per cent. Conversely, if the same company takes a three-year loan in India at around 7.75 percent, the cost of converting it into dollars is much lower. Due to which it is proving more profitable to take dollars out of the country. When companies do this, the pressure on the rupee increases.