Worried at the recent fall in rupee to a 13-month low, foreign investors are hedging their investments in Indian bonds in the offshore non-deliverable forward market and this rush for hedging has lifted the three-month NDF rate by a massive 100 basis points so far in December.
Concerns over global growth and expectations that the US Federal Reserve would raise interest rates as early as June 2015, the rupee fell 2.5% in December in tandem with the fall in most emerging market currencies. The rupee closed at 63.57/$ on Friday.
“When there is a risk aversion, investors either exit or hedge their positions. That is why we are seeing a rise in the NDF rates,” said Ashish Parthasarthy, head of treasury at HDFC Bank.
Foreign institutional investors have bought $26.3 billion worth of Indian bonds so far in 2014. In December, FII bought $1.9 billion of bonds. “Investors were keeping positions open as the rupee had been fairly stable. But some are hedging now because of the rupee’s recent fall,” said a senior currency dealer at a US-based bank.
“FIIs typically keep positions unhedged, but if there is a need to hedge and if the local currency falls, hedging is done in the NDF market,” the dealer added.
FIIs prefer offshore market for hedging as the cost in the NDF market is lower than the onshore forward market. Moreover, the NDF market is unregulated and, therefore, far flexible to punt than the onshore market. For instance, the cost to book a three-month hedge in the NDF is currently around 7% while in the onshore market, the rate would be around 7.35%.
FIIs were keeping investments in rupee and bonds unhedged given the stability of the rupee between June and October when the currency was stuck in 61-62/$ band. However, the currency began falling steadily thereafter mainly due to RBI’s dollar purchases and then due to investors’ aversion to emerging market currencies in December. Currency derivatives both offshore and onshore are predicting a weak rupee for the January-March quarter with the three-month non-deliverable forward hovering around 64.60/$ while the onshore market predicting a fall of the rupee to 64.45/$.
Concerns that the rupee will remain weak and is unlikely to recoup its recent losses have risen after RBI was seen more often buying dollars than selling in the forex market.
RBI had bought $19.38 billion from the spot forex market in the April-September period.