The premiums on the Indian rupee are unlikely to fall much further, with current levels almost fully incorporating the U.S. and India interest rate differentials, analysts said.
The USD/INR 1-year implied forward premium plunged almost 50 basis points (bps) in November to 1.88% – its lowest in more than ten years – mainly due to the shrinking U.S. and India interest rate differentials.
The 1-year rupee overnight index swaps declined about 30 bps in November, helped by a better inflation outlook domestically that prompted traders to lower their expectations on the Reserve Bank of India's terminal rate.
On the other hand, the 1-year U.S. SOFR (secured overnight financing rate) linked swap inched higher in early November after the Federal Reserve Chair signalled a higher terminal rate.
The difference between the two rates has now dropped to about 1.85%, near the 1-year USD/INR premium level.
"The forward premium is now in line with interest rate differentials," said Abhishek Goenka, CEO at IFA Global. This suggests there was little downside for USD/INR premiums from here, he added.
"Plus, there seems to be reasonable certainty around the U.S. terminal rate in this cycle (of around 5%) and RBI repo rate is likely to peak around 6.50%," Goenka said.
Apart from interest rate differentials, the RBI's activity in the forward market has contributed to the fall in premiums.
Public sector banks have been on the offer (doing buy/sell swaps) in near deliveries up to January, which we think is on behalf of the RBI, said a trader at a large private sector, who did not wish to be identified.
The RBI buy/sell swaps are likely for changes in its forward book and once the RBI halts its operations in forwards, premiums will move higher, the trader said.
Near-term forward implied yields are lower than the far forwards and below the current overnight USD/INR swap rate. For instance, the December premium is at 0.35 to 0.37 paisa per day compared to 0.43 cash swap rate.
"RBI's operations matter on shorter timelines. But ultimately, premiums should reflect interest rate differentials," Abheek Barua, chief economist at HDFC Bank, said.
"Based on that, we reckon that current levels are too low."
Barua reckons that the fair level for the USD/INR 1-year premium is around 2.10 to 2.25%. (Reporting by Nimesh Vora; Editing by Savio D'Souza)