Indian banks leave sizeable FX risk open on overseas deposits, creating potential rupee overhang

MUMBAI: 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, five bankers said.

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.

Foreign banks are largely hedging exposure. Most state-run banks and several private-sector Indian lenders have not, the bankers said.

One banker at a mid-sized state-run lender said their bank had decided not to hedge the interest-payment FX exposure for now, citing the high cost and recent comfort provided by the RBI’s intervention-driven rupee rally.

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“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 official said.

All five bankers requested anonymity because they were not authorised to speak to the media. The RBI did not immediately respond to an email seeking comment about the risk of unhedged interest payments.

Costly hedges, rupee risks

It costs banks about 3% a 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, bankers said.

The head of FX trading at a private-sector bank said the cost of hedging is prohibitive, particularly given how recent RBI intervention has made risk-reward on the rupee “asymmetrical.”

Positive developments are more likely to trigger a large rupee rally than negative news is to weigh on the local currency, he said.

The rupee this week climbed to a two-month high amid persistent RBI intervention, boosted by greater firepower from the overseas FX deposits, analysts said.

That respite could be tested, however, with Brent crude oil prices again approaching $100 a barrel and markets pricing a 60% chance of a rate hike by the U.S. Federal Reserve next week.

With at least half of banks’ interest-cost exposure unhedged, renewed rupee weakness could trigger a rush for dollars. A move toward 96-97 per dollar could shift banks’ limited inclination to hedge, said a second banker who heads FX trading at a private-sector bank.