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Informist, Friday, May 23, 2025

 

By Sourabh Kumar and Pratiksha

 

MUMBAI – Premiums on dollar/rupee forwards have declined around 25 basis points so far this month, touching a near one-month low of 2.05% on Friday. This fall in premiums is likely to continue in the near term with traders expecting the interest rate differential between the US and India to narrow. Market participants expect premium on the one-year dollar/rupee forward to fall to as low as 1.90-1.85% in the next three months. The last time it had fallen to 1.85% was in August last year.

 

The primary reason behind the recent slump in premiums is the jump in US Treasury yields due to worries over the overall health of the world's largest economy amid the ongoing uncertainty around President Donald Trump's trade policies and concern over widening fiscal deficit. The benchmark 10-year US Treasury yield has risen around 40 bps so far this month. Premiums on forwards of a currency pair are reflective of the interest rate differential between the two countries.

 

Market participants expect the US Federal Reserve, which has cut interest rates by 100 bps in this cycle, to stand pat on rates amid the uncertainty surrounding the impact of Trump's volatile trade policies. 

 

The US Federal Open Market Committee has kept the federal funds target rate range unchanged at 4.25-4.50% for three consecutive meetings ever since Trump was sworn in as the US president in January. The odds of a rate cut at the next FOMC meet outcome on Jun. 18 was only 5.3% as of Friday, as per CME FedWatch tool.

 

On other hand, back home, the Reserve Bank of India is expected to go for further rate cuts, after having already slashed rates by 50 bps since February, considering the continuous fall in inflation and its focus on supporting faltering growth. The RBI's Monetary Policy Committee is expected to go for at least 50 bps of rate cuts in the current cycle, leading to narrowing of the differential between Indian and US yields and exerting pressure on the premiums.  

 

"The inflation differential between the two countries (the US and India) is the lowest in the decade, so the prime root reason (of fall in forward premiums) is this," said V.R.C. Reddy, head of treasury, Karur Vysya Bank. "These policy uncertainties are also lingering on the US market. But on the yield side, we are in a comfortable position. Because of the tariff impact, they (US) are anticipating the inflation will go upside, and they do not have more space to cut the rate, whereas India has more space to cut rates."

 

Liquidity in the banking system has remained in surplus since Mar. 29, with the RBI amping up measures for the same, weighing on forward premiums. On May 16, the liquidity surplus in the banking system touched INR 2.5 trillion, the most since Nov. 6. Further, the average daily liquidity surplus since Mar. 29 is INR 1.5 trillion.

 

Market participants expect the liquidity surplus to only improve further, mainly owing to the RBI's surplus transfer to the government for 2024-25 (Apr-Mar), which will accelerate the fall in premiums, especially near tenure forward premiums.

 

Experts expect the RBI to transfer a record surplus of INR 2.8 trillion to the government for FY25. "I don't think there is anything which is changing--we are not increasing our fiscal deficit, they (the US) are, and we are cutting our rates and they are not, plus liquidity (in Indian banking system) is huge, so I don't see any reason why it (forward premiums) shouldn't come down," said Ritesh Bhusari, joint general manager, treasury, at South Indian Bank.

 

Further, a bright outlook for the Indian rupee owing to broader weakness in the US dollar has prompted exporters to hedge their foreign exchange exposures around the current dollar/rupee levels, pushing the forward premiums lower, dealers said. The dollar/rupee exchange rate is a component of the premium received by exporters for selling forward dollars.

 

"Currently, we are recommending exporters to lock in their near-term hedges, but once the picture is clearer on the rupee, I think more exporters will start hedging, because the rupee will appreciate from here," said a senior treasury official at a big state-owned bank.

 

Market participants see the rupee rising as much as 84.00 per dollar in the medium term. MUFG Bank said in a report Monday that it expects the rupee to rise to 85.00 by June and 83.50 by March. While the tide can turn the other way, given the uncertainty on the US front. For now, most factors are pointing to a further decline in the dollar/rupee forward premiums.  End

 

US$1 = INR 85.94

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Akul Nishant Akhoury

 

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