Fed outlook, RBI intervention may push Indian rupee premiums higher - analysts

Indian rupee premiums, already hovering at two-month highs, are likely to climb more on expectations of intervention by the Reserve Bank of India (RBI) and a less-hawkish outlook from the U.S. Federal Reserve, analysts said.

The USD/INR 1-year forward premiums have jumped to 1.96 rupees from a multi-year low of 1.34 rupees reached on Dec. 6. This has pushed the USD/INR's 1-year cost-of-carry to 2.36% from around 1.60%.

Two things make us think that there is room for premiums to rise further - increasing the likelihood that the Fed will not reach the 5% peak rate and that the RBI wants premiums to be higher, said a swap trader at a public sector bank. He did not want to be identified on account of the bank's internal policies.

Markets will want to position themselves for Fed rate cuts later this year, pushing far maturity premiums up, a trading head of a private sector bank said.

The Fed is poised to further dial back the size of the rate hike to 25 basis points (bps) on Feb. 1. Futures are pricing in about 50 bps of total rate cuts in the second half of the year.

The public sector trader recommends sell/buy swaps in far forwards and funding them by buy/sell up to two months to take out the risk of daily rollovers.

A sell/buy USD/INR swap involves buying dollars for the spot date and selling for a future maturity date. The difference in the two rates is a function of the interest rate differentials between the U.S. and India and demand and supply.

The RBI has changed the demand and supply dynamics by intervening in the forward market, according to traders. Over the last several weeks, the RBI has been regularly conducting sell/buy swaps in mid- and far-maturities via public sector banks to lift premiums.

The central bank's monthly bulletin, out late Thursday, revealed a big jump in its forward book. Net forward dollar purchases surged from just under $250 million in October to around $8.5 billion in November.

The maturity profile showed that most of the forward dollar purchases were in the three months-and-above bucket.

The higher premiums increase the cost-of-carry, making it more expensive for importers to hedge and more attractive for exporters.

“There will be an upside to premiums before it plateaus out. More important will be the Fed (for the direction of premiums),” said Madan Sabnavis, chief economist at Bank of Baroda.

“The RBI would like to have premiums at normal levels. If the premiums are low, they would like it to go up.”

RBI Deputy Governor Michael Patra, at the December post-policy meeting press conference, had said premiums were poised to rise.