Even as the banking system is witnessing an increased rupee liquidity, the continued outgo of foreign portfolio investors (FPIs) from Indian assets has ensured a dollar shortage despite lower demand for oil-import bills.

On top of this, some Indian could be converting their rupee liquidity in dollar deposits, accentuating the demand for dollars and bringing down the forward premium for it.

The forward premium comes down when demand for the spot dollar is more than the future dollar. The three-month dollar premium was 4.81 per cent on April 8, it is now at 3.93 per cent.

So far in this calendar year, FPIs have withdrawn $17.38 billion from the Indian markets. Of this, $10.4 billion is in debt, and about $7 billion in equity. However, a crash in oil prices meant that the demand for dollars from oil marketing companies has remained tepid. Meanwhile, continue to park in excess of Rs 7 trillion of their surplus liquidity with the central bank.

A section of the currency market now doubts if some are playing an arbitrage game with liquidity in hand.

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With the surplus liquidity of Rs 7 trillion, and banks reluctant to take credit risk and duration risk, lenders are investing mostly in short-term treasury bills.

A three-month treasury bill is currently yielding 3.60 per cent. However, the reverse repo rate, which the banks get by parking their excess liquidity, is 3.75 per cent. So, instead of investing in treasury bills, if banks do a buy-sell swap (buy spot dollars to supply the same dollar in the market three months later), they can earn 3.9 per cent interest rate, which is the forward premia for three months.


Now, if the same dollar is invested overseas, banks can get 1 per cent annual return on the deposits. All percentages mentioned here are annualised.

With this, the perceived return on an annualised basis works out to be 4.9 per cent for banks. Even if the bank has to come back and borrow from the Reserve Bank of India (RBI) because of liquidity shortage, it can do so through the RBI liquidity window at repo rate, which is now at 4.4 per cent, and doesn’t seem to be going up anytime soon.

This means that in the worst-case scenario, the bank can earn a risk-free arbitrage income of 0.4 per cent on their liquidity, without doing anything.

“We are seeing quite a few nationalised banks doing this and therefore we are seeing the forward curve getting received, especially near months,” said Abhishek Goenka, founder and CEO at IFA Global.

However, the treasurer of a bank did not agree to this.

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“Such arbitrage is not risk-free. LIBOR (London Interbank Offered Rate) can drop to negative territory, too, in this coronavirus-hit environment. It has to be a daring bank that would go and do it and in full view of the RBI,” said the treasury head.

The short-term premia could be falling because the dollar demand three months down the line is very less.

“The bill payment obligation (mostly oil-related) is less. And hopefully, in three months the world will have a better grip on the Covid crisis. Investments will start flowing in and dollar liquidity will improve substantially,” said the treasurer.

And it is not that the country is witnessing a free flow of dollars out. Data released on Friday showed that the foreign exchange reserve of the RBI improved to about $480 billion, as of April 17, as oil-related dollar demands collapsed.

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