Indian companies that buy foreign currency to settle imports are continuing to buy forward dollar contracts to fix future exchange rates, despite a central bank requirement that has raised the cost of offering those contracts. The Reserve Bank of India now requires lenders to set aside cash equal to 20% of the notional amount of the forward dollar contracts they sell, and banks are charging clients to cover that burden.
Bank treasuries have passed the compliance cost on to importers, who are consequently paying an additional 11 to 14 paisa per month to secure future dollar purchases. Even with these higher fees, bankers said the contracts remain a preferred means of protection against a potential weakening of the rupee. The bankers spoke on condition of anonymity because they were not authorised to speak to the media.
The recent behaviour of the rupee has helped blunt the sting of the increased hedging cost. The currency recovered following a set of measures from the Reserve Bank of India aimed at supporting the rupee, strengthening to a high of 94.72 per dollar on Wednesday from levels near 96.70 last week, according to the people interviewed.
Shorter tenor hedges
Officials in private-sector treasuries said the extra charge varies by the lender's cost of funds and increases with contract length. As longer-dated forwards are now relatively more expensive, hedging activity has become concentrated in shorter-term contracts, typically up to three months.
Market participants noted that near-term contracts carry a lower incremental cost than longer-dated ones. That dynamic has shifted importer preferences toward brief tenors as companies seek to balance protection and affordability.
"For importers this is a good opportunity to buy dollars and hedge. The approach should be to hedge as short-term as possible, and to use low-cost options," said Samir Lodha, managing director at Mumbai-based QuantArt Market Solutions.
Lodha added that option structures can offset part of the additional hedging cost created by the central bank's new measure. Bankers and market practitioners pointed to those option strategies as one way to reduce the net expense of protecting against currency moves.
However, the persistence of importer demand for forward contracts complicates the Reserve Bank of India's objective of curbing dollar demand. Central bank interventions that spur rupee rallies can prompt importers to re-enter the forward market to lock in more favourable rates, potentially reviving dollar demand that the regulator is attempting to restrain.
Overall, banks are adjusting pricing to reflect a 20% cash reserve requirement on forward contracts. Importers are responding by shortening the tenor of hedges and incorporating options where cost-effective, while the rupee's recent strength has made hedging more palatable despite higher monthly charges.