Indian banks have left much of their future interest payments on overseas FX deposits unhedged, creating a source of potential dollar demand that could compound depreciation pressure in a rupee-weakening scenario. According to reports from The Hindu BusinessLine, The Economic Times, and Business Standard, lenders have raised more than $127 billion in such deposits since the central bank introduced them as part of one-off measures to strengthen India's balance of payments in the face of surging oil prices in June. While the Reserve Bank of India's special swap facility shields banks from FX risk on the deposits' principal amounts, interest payments need to be managed by lenders independently. The deposits were part of a broader strategy to mobilize overseas funds and strengthen India's external position amid global economic pressures.
It costs banks about 3% per year to hedge FX risk on interest payments for deposits of 3- to 5-year tenors, for which the interest is paid when the deposits mature, rather than periodically. As reported by The Hindu BusinessLine, The Economic Times, and Business Standard, foreign banks are largely hedging exposure while most state-run banks and several private-sector Indian lenders have not. One banker at a mid-sized state-run lender explained their decision to not hedge the interest-payment FX exposure, citing the high cost and recent comfort provided by the RBI's intervention-driven rupee rally. The official stated that at the moment, the expectation is that interest payments can be handled via spot dollar purchases when needed as opposed to locking in protection. The head of FX trading at a private-sector bank noted that the cost of hedging is prohibitive, particularly given how recent RBI intervention has made risk-reward on the rupee 'asymmetrical'.
The rupee this week climbed to a two-month high amid persistent RBI intervention, boosted by greater firepower from the overseas FX deposits, according to analysts cited by The Hindu BusinessLine, The Economic Times, and Business Standard. However, this respite could be tested with Brent crude oil prices again approaching $100 a barrel and markets pricing a 60% chance of a rate hike by the US Federal Reserve next week. The head of FX trading at a private-sector bank noted that positive developments are more likely to trigger a large rupee rally than negative news is to weigh on the local currency, given how recent RBI intervention has made risk-reward on the rupee 'asymmetrical'.
With at least half of banks' interest-cost exposure unhedged, renewed rupee weakness could trigger a rush for dollars. As reported by The Hindu BusinessLine, The Economic Times, and Business Standard, a second banker who heads FX trading at a private-sector bank warned that a move toward 96-97 per dollar could shift banks' limited inclination to hedge. The bankers requested anonymity because they were not authorized to speak to the media, while the RBI did not immediately respond to an email seeking comment about the risk of unhedged interest payments.
