MUMBAI: Indian banks have left a significant portion of their future foreign-exchange exposure on interest payments from overseas deposits unhedged, potentially increasing demand for US dollars if the rupee comes under renewed depreciation pressure, bankers said.
Indian lenders have raised more than $127 billion through overseas foreign-currency deposits introduced by the Reserve Bank of India (RBI) as part of measures to strengthen the country’s balance of payments amid higher oil prices.
The RBI’s special swap facility protects banks against foreign-exchange risk on the principal amount of the deposits, but lenders remain responsible for managing the currency exposure associated with future interest payments.
Why are Indian banks leaving the exposure unhedged?
Foreign banks are largely hedging their exposure, while several Indian private-sector lenders and most state-owned banks have so far opted not to fully hedge their interest-payment obligations, according to five bankers.
Bankers said the cost of hedging has been a major factor. Hedging foreign-exchange exposure on interest payments for deposits with maturities of three to five years costs banks about 3% annually, they said.
One banker at a mid-sized state-owned lender said the bank currently expected to meet its future interest obligations through spot dollar purchases rather than locking in hedges.
Could renewed rupee weakness increase dollar demand?
The strategy could expose banks to higher costs if the rupee weakens significantly. With at least half of banks’ interest-cost exposure reportedly unhedged, renewed depreciation could lead lenders to seek dollars in the spot market.
The rupee recently strengthened to a two-month high, supported by intervention by the RBI and increased foreign-exchange liquidity from the overseas deposits.
However, rising crude oil prices and expectations surrounding US interest rates could put renewed pressure on the Indian currency. Brent crude has been approaching $100 a barrel, while markets have been pricing a higher probability of a US Federal Reserve rate increase.
A private-sector bank’s foreign-exchange trading head said a move by the rupee towards 96–97 per dollar could prompt banks to reconsider their limited use of hedging.
The RBI did not immediately respond to a request for comment on the potential risks from unhedged interest payments.