India?s foreign exchange market has factored in a 25 basis point hike in key interest rates in the upcoming policy review with the rupee plunging to a 0ne-year low in the forward market this month.
In anticipation of small hike in policy rates, the premium commanded by the forward dollar to the spot dollar/rupee rate have risen sharply, dealers said.
Premiums have been rising for some time as the Reserve Bank of India tightened rates and signalled more such ?baby? steps to rein in demand-side upward pressure on inflation and to exit from easy money policy of 2008-09 (April-March).
?In the past couple of months, forward premium rose due to a combination of rate hike fear on account of high inflation and dollar demand by importers,? said Ananth Narayan, managing director and head rates, forex and credit, South Asia at Standard Chartered Bank.
After two rounds of policy rate hikes in July (first on July 3 and then July 27) and inflation continuing to remain in double digits, the premium on the 12-month forward dollar/rupee rose 195 bps to an annualised 4.75% from 2.80% on July 2.
?Forward premium has not come down after the last rate hike (on July 27) as inflation continues to remain high raising fear of further monetary tightening by the central bank,? said Subramanian Sharma, director of Greenback Forex Services, a consultancy.
The one-year premium may top 5% if RBI continues with its tightening policy against inflation.
?Forward premium could rise by 15-20 bps from the current level, even if RBI hikes rate by 25 bps,? said Sharma.
Dealers were of the view more-than-expected spike in industrial growth would goad RBI to continue with its calibrated policy tightening strategy.
?If RBI decides to continue with its rate hike policy, than forward premiums could easily cross the 5% mark by month-end,? said a dealer at Standard Chartered.
Further, the rise would depend on the tone of RBI?s remarks in the policy review on Thursday, he said.
However, some expect the rise will be capped by the big foreign exchange inflows that India?s robust growth story is set to attract.
In the next few weeks, foreign institutional investors would be making a beeline to several top-line equity offerings that are scheduled.
?We have a lot of capital inflows coming in September-October because of IPOs and the expectation is that rupee would appreciate,? said Narayan of Standard Chartered Bank.
That might put a cap on the rise in forward premiums, he said.