The Reserve Bank of India’s historic defense of the rupee bought the currency some reprieve, but at a steep cost.
The RBI’s most aggressive currency intervention in more than a decade is rippling across India’s financial markets. Tighter restrictions have disrupted most of the hedging activity that typically helps absorb currency shocks, while sowing confusion as traders pressed the central bank to ease the rules and clarify their scope. “We will have to swallow poison for a long-term gain. Banks and companies use currency forwards and swaps to protect themselves against the risk that future dollar payments become more expensive.
Because the RBI’s restrictions raised the cost of using derivatives – contracts linked to an underlying asset or price, such as the dollar-rupee exchange rate, hedging has become more expensive.
“Hedging costs shooting higher and illiquid markets are the unintended consequences,” said Anshul Chandak, head of treasury at RBL Bank in Mumbai.
The RBI sought to clear up some of the confusion on Thursday, saying the new rules would apply only to transactions used to hedge foreign-exchange risk and not to trades banks conduct to buy and sell currencies for clients and keep the market functioning. Trading volumes have also fallen sharply, prompting Goenka to advise clients to hedge only their immediate needs. Banks are nevertheless bracing for the fallout.
The forwards market has become “extremely dislocated,” said Abhishek Goenka, chief executive officer of IFA Global, a forex advisory firm. It is now cheaper for companies to borrow rupees and swap them into dollars than to borrow the US currency, he said. Treasury desks will likely see subdued client foreign-exchange business and potential losses on their fixed-income trading books in the October-December quarter, RBL’s Chandak said.
