Bearish Rupee bets drive hedging costs to highest since 2022

A HDFC Bank Ltd. teller counts Indian 500 rupee banknotes at the company's bank branch in Mumbai, India, on Tuesday, Sept. 12, 2023. HDFC Bank wants to use home lending as a gateway for the world’s sixth largest lender to capture more consumer finance customers with loans on everything from air conditioners to cars and TVs. Photographer: Dhiraj Singh/Bloomberg

The cost to hedge foreign-exchange risk in Indian assets rose to the highest in more than two years as bets mount that authorities are easing their iron grip on the rupee.

Dollar-rupee three-month offshore forward points, the cost of locking in forward dollar purchases, touched levels last seen in November 2022 on Thursday.

The rise in the NDF points looks to be a combination of increased hedging demand by foreign investors and broad dollar demand, said Michael Wan, senior currency analyst at Mitsubishi UFJ Financial Group, Inc. in Singapore. Expectations are still high for continued weakness in the Indian rupee, he added.

The Indian rupee has plumbed record lows in recent weeks and is expected to extend losses on the back of a stronger dollar. That’s spurred speculation about the Reserve Bank of India loosening its tight grip on the currency, compared to just a few weeks ago when its focus remained on squeezing volatility.

Emerging-market currencies have come under pressure on expectations that President-elect Donald Trump’s potential tariffs and tax cuts will fan inflation and prompt the Federal Reserve to slow interest-rate cuts.

The rupee is likely to weaken to 86.8 per dollar this quarter, according to MUFG, while Citigroup Inc. sees it falling to 86.35. The currency fell as much as 0.1% to a new record low of 85.94 per dollar on Thursday.

Slowing economic growth and foreign outflows from stocks have also weighed on the currency. A falling rupee and higher hedging costs mean lower returns on rupee bonds, which were one of Asia’s top performers last year.

The FX-hedged annualized return on the 10-year bond held steady through the first half of 2024. Then, it plunged sharply in December as rising forward points drove up foreign investors’ hedging costs, Morgan Stanley analysts Nimish M. Prabhune and Gek Teng Khoo wrote in a note.