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Repo rate hike pushes up $ premiums
June, 16th 2008

The hike in the repo rate has led to a steep hike in premiums payable on forward contracts, giving rise to fears that rates in India would be on an upward trajectory and trigger dollar demand among importers.

On the other hand, exporters have also not been hedging their receivables at the moment, which traders say, could be because they would have exhausted their positions by now.

The premium payable on the one-month forward contract has risen by close to 200 basis points since the past couple of days to 4.36%, while premia on the longer-tenor contracts have moved up in a range of 50-75 bps to hover in the 2.50-2.90% range.

Closer home, premia have also risen, tracking cash conditions which are on a tightening mode, especially after the hike in the repo rate and advance tax payments which corporates will make this week.

A senior forex dealer with a private sector bank explained, Forward premia are abnormally high at present, and it could be a result of the players artificially jacking up the rates, by taking speculative positions to maximise their returns. He further added that foreign banks have also been very active in the non-deliverable forward (NDF) market, especially a leading American and British Bank which have a leading position in India.

Typically, foreign banks buy dollars in the spot market and sell them simultaneously in the offshore NDF market, in an attempt to arbitrage the price differential. On Friday, rates on the offshore NDF market had closed at 43.16/26 per dollar, much weaker than the onshore rate of 42.94/95.

A forex strategist with a private bank said with FIIs increasingly pulling out of Indian equity markets and rising price levels, the rupee is expected to weaken further. This has also led to increased dollar demand from FIIs in the spot currency market, while in the forward market, most of them are taking long positions on the dollar within Asia, he added.

Most FIIs are reported to have bought dollars at 42 or 41.5 levels, but with the RBI intervening constantly at the 43.95-levels, this could be a good time for them to cash out, according to market sources.

A senior forex trader with a multinational bank said, the repo rate hike has been the key trigger for premia to inch upwards. This has led to some paying interest among importers, given that the interest differential between India and the United States would widen further now. The Reserve Bank of India is the only seller of dollars in the foreign exchange market at the moment.

After the repo rate was hiked last week by 25 basis points to 8%, there has been a growing perception that rates in India would be northward bound at least for the short-term. Going forward, considering that inflation levels could soon turn into double-digit figures, market participants are now bracing themselves for another hike in the cash reserve ratio (CRR).

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