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Informist, Wednesday, Oct. 23, 2024

 

By Pratiksha

 

NEW DELHI – The Reserve Bank of India may have squeezed volatility out of the rupee's spot exchange rate, but global and domestic factors have sent premiums on dollar/rupee forwards on a veritable roller coaster due to rapid repricing of views on interest rates in India and the US.

 

On Sept. 25, the one-year dollar/rupee forward contract rose to an over 17-month high of 2.42%, before slumping to 2.17% on Oct. 16 – the lowest since Sept. 4 – as hopes of a repeat of last month's 50-basis-point rate cut by the US Federal Reserve have seemingly faded in the face of solid economic data. Prices of Fed funds futures suggest a nine-in-ten chance of a 25-bps rate cut by the Fed on Nov. 7. Meanwhile, US Treasuries crashed on Monday, with yields on 3-years-plus papers now 50 bps higher since the Fed's Sept. 18 rate cut.

 

"Looking ahead, the Fed is expected to implement a total of 100 bps rate cuts in 2025, while the RBI is yet to move to a rate cut. This suggests that forward premiums could rise again as these developments unfold," said Amit Pabari, managing director of CR Forex.

 

Views on interest rates in India have also undergone a sea change in the span of a few days. After the RBI's Monetary Policy Committee changed its stance to neutral from withdrawal of accommodation on Oct. 9, a first repo rate cut in four and a half years at the December meeting was being baked in, before the September CPI inflation print came in at an unexpectedly high 5.49%. Governor Shaktikanta Das further doused the rate cut embers last week, saying a rate cut at the current juncture would be "premature" and "risky".

 

"The market...sort of reacted in a way that the expectation of a rate cut (in India) was built for December and now that (expectation) looks early," said Anshul Chandak, head of treasury at RBL Bank. Chandak added that the "largest component of uncertainty" was due to geopolitics, with crude oil prices also playing a "critical role". Brent crude oil prices had topped the $80-per-barrel mark earlier this month and have since cooled and consolidated around $75 per barrel.

 

Further complicating the pricing of dollar/rupee forwards is the uncertain outlook on liquidity conditions, dealers said. The common perception of the RBI's liquidity strategy is that it will tolerate easy liquidity, but not necessarily supply surplus liquidity in the event of tightness, typically observed during the festival season. As a result, traders are unsure whether present liquidity conditions can be priced into forward premiums if the banking system could be headed for a cash crunch.

 

UNCERTAIN FLOWS

Certain idiosyncratic factors have also imparted instability to dollar/rupee forward premiums. While the much-awaited initial public offering of Hyundai Motor India Ltd. eventually sailed through last week, the initial poor response caught traders off guard. This led to the cash-tom weighted average dropping to a one-month low of 0.29 paise on Oct. 15, the first day of the IPO. Meanwhile, the overnight cost of deploying dollars had dropped to 0.10 paise on Oct.10 – its lowest in almost a month – before rising to a one-month high of 1.25 paise on Oct. 18.

 

Lack of sufficient dollar liquidity has also weighed on premiums, according to dealers, who have noticed a dollar shortage because of continuous outflows from domestic markets, triggered by geopolitical risks and US rate cut expectations. Money has also moved to China after the world's second-largest economy announced a slew of stimulus measures to support faltering growth.

 

So far in October, foreign portfolio investors have withdrawn almost $8.3 billion on a net basis from India. This is the largest monthly figure since March 2020, when the coronavirus pandemic really hit India.

 

"The rate difference (between India and the US) will push FIIs to exit the capital market. The Indian market is trading at higher valuation while China is trading at half of its valuation," said Gaurav Sharma, head of equity, commodity, and currency research at Globe Capital Market.

 

According to BofA Securities' latest Asia Fund Manager Survey, growth expectations for China have "sprung back to life". "Notably, the upliftment in sentiment on China has come at the expense of India as seen from the dissipation of the gap in allocations," BofA Securities said in a note on Oct. 15.

 

With views constantly changing in response to policy measures and new data, market participants expect the dollar/rupee forward market to remain volatile. However, with the US Fed seen lowering interest rates further in the coming months, most currency market players believe the one-year dollar/rupee forward premium will broadly be on an upward trajectory.  End

 

US$1 = INR 84.08

 

Edited by Avishek Dutta

 

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