Listen to this article in summarized format
Bankers believe this has had an unintended consequence for the currency: Making it expensive for overseas funds to buy rupee-denominated assets due to high hedging costs.
In effect, this could be seen as partially counter-productive as a tool that's intended to give the rupee a firm floor.
Also read: RBI survey: Household inflation expectations hit 10% for next year
"For foreign investors, particularly those who fully hedge their currency exposure, a rise in forward premiums increases the cost of hedging and reduces the attractiveness of the overall rupee return, which could marginally discourage some debt/portfolio inflows," said Kunal Sodhani, head of treasury at Shinhan Bank India.
The one-year dollar-rupee forward premium included blended cost rose to 8.65% from 7.40% less than a month ago. Although it retreated to 8.45% on Thursday, foreign investors will still find it expensive to hedge their local investments. To be sure, this reflects comprehensive hedging costs an overseas investor would incur, bankers said.
Two traders said the Reserve Bank of India (RBI) may have shifted its focus on forward market dollar sales Thursday to help cool surging forward premiums that threaten the spot rupee.
Forward rupee premiums for different tenors were seen rising until Wednesday. The rupee, meanwhile, closed a tad weaker at 96.79 a dollar against Wednesday's close of 96.7750. The currency opened the day stronger at 96.68 but came under pressure in the afternoon tracking the rising fuel prices. It remains within sight of its all-time low of 96.96.
"In the current environment, the larger impact is likely to be on hedging behaviour-higher premiums may encourage exporters to sell dollars forward while making forward hedging more expensive for importers and borrowers," Sodhani said.
Case for USD Outflow?
Bankers said the situation is such that for large Indian companies with offshore operations, it is much cheaper to borrow from the local market in rupees and swap them into dollars for overseas use.
Also read: Rupee is undervalued, not unmoored: RBI must ride out global market turbulence
"Many companies are seriously looking at this alternative because overseas rates have gone up. A top-rated Indian company can get a three-year loan at about 5.50% abroad. With around 3.25% of hedging cost, this loan could go beyond 9%," said a senior treasury official, who declined to be named. "But if it chooses to borrow 3-year money at about 7.75% here, the cost of swapping it to the dollar is much less, which makes it cheaper to take dollars abroad."
Higher forward dollar premiums and cheaper ways to take money abroad could put further pressure on the rupee, making the RBI's job of managing the currency more difficult, bankers said.