Fall in onshore forward premiums could push Indian rupee even lower

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A shortage of cash dollars and forward market intervention by the Reserve Bank of India which has pushed onshore 1-year forward premiums to their lowest levels in more than a decade could pressure the rupee to new lows, traders and analysts said.

The one-year annualised forward premium stood at 2.91% at 0830 GMT, compared to its close of 2.82% on Wednesday. It had touched a low of 2.80% in the previous session, its lowest level since Nov. 25, 2011.

“The situation is really bad. There is dollar scarcity which is getting compounded by RBI taking delivery of maturing forward contracts,” the head of forex trading at a private bank said.

On Wednesday, the rupee touched a record low of 78.39 against the dollar despite a sharp fall in global crude oil prices, pushing forward premiums down. The rupee was trading at 78.34/35 on Thursday.

The smaller forward premia is likely to make carry trades less attractive for overseas investors and an unwinding of these carry trades would put further downward pressure on the spot rupee, pushing it towards 79-80 levels, traders warned.

Premia could fall further and some form of sell/buy swap window may be needed if the situation remains as grim, the trader said.

“RBI is doing a lot of buy/sell swaps to prevent showing a fall in spot foreign exchange reserves I guess. This is amplifying the signal from the interest rate spread between India and the U.S.,” said Vivek Kumar, economist at QuantEco Research.

The RBI until last year was buying forward dollars to prevent an infusion of rupee liquidity into the spot market when it intervened to curb excessive appreciation in the rupee.

“Persistent FPI outflows amid a wide trade deficit could also be creating a dollar shortage problem,” Kumar said, referring to foreign portfolio investment.

India's foreign exchange reserves fell to $596.46 billion as of June 10 from $601.06 billion a week earlier.

“A bit of dollar funding stress is evident globally as well, as is seen in the LIBOR-OIS spread and widening cross-currency swaps. However, RBI forward intervention has made it more acute in India's case,” IFA Global Research said in a note.

A shortage of cash dollars could become self-perpetuating like during the 2008 crisis if importers start hedging aggressively and could put spot rupee levels under pressure, Kumar said.

“RBI would need to reorient its intervention startegy towards drawdown of spot reserves alone and thereby meet the dollar demand,” he added.