Mumbai: Investors should borrow in rupees and lend them once local money-market rates have risen and do the opposite in dollars, JPMorgan Chase and Co. said.
Traders should acquire a rupee liability and a dollar loan with a single transaction, a so-called forward currency swap, to profit from both, said Vikas Agarwal, fixed-income strategist at the third-biggest US bank. They should exchange rupees for an equivalent amount of dollars at a future date and swap interest-rate payments in the two currencies until then, he said.
“Swapping rupees for dollars in the forward market helps take advantage of the widening India-US rate differential,” Mumbai-based Agarwal said in an interview. “Policy action in India may seek to contain the surge in inflation by draining funds from the money market, pushing overnight rates higher,” he said.
The overnight borrowing costs of Indian banks will rise from a three-month low as policymakers drain money from the financial system to curb the fastest inflation in three years, Agarwal said. The cost of funds in the world’s largest economy will fall as it heads for a recession, he said.
JPMorgan recommends agreeing to swap rupees for dollars in February 2009 by paying the so-called forward premium, which is calculated using the difference between rupee and dollar interest rates. The party that takes on the obligation to deliver rupees in the swap must pay the premium since Indian rates are higher. The one that agree to swap rupees in future must buy them now from the spot market to guard against a rally in the currency.
The premium on rupee-for-dollar swaps due in February was 63 paise per dollar above the spot rupee rate of 39.945 in Mumbai, according to data compiled by Bloomberg. It fell to negative 2 paise on 21 February. Investors should exit the trade with a profit by making a reverse agreement, one swapping dollars for rupees in February, by receiving the forward premium once it has risen to Re1, JPMorgan said.
Borrowing costs between local banks may rise as India sells short-term debt to drain funds from the financial system. The government will sell Rs9,000 crore of bonds and bills this week to absorb excess cash after not offering any last week. The rate at which banks borrow overnight from each other fell to 3.75% on 14 April, the least since 4 January.
The central bank may buy rupees from the currency market and ask banks to hold more funds in reserve to help temper inflation by reducing the supply of money, Agarwal said.
India’s wholesale prices rose 7% in the week ended 22 March from a year earlier, the fastest rate of inflation since 2004, the ministry of commerce and industry said on 4 April. The world’s second-fastest growing major economy will settle for slower expansion to curb price gains, finance minister P. Chidambaram said on 28 March.
“The Reserve Bank of India (RBI) may buy rupees in the spot market and swap them back for dollars in the forward market” to avoid the risk of currency losses, Agarwal said. Demand for dollars in the forward market from the central bank will help boost the forward premium on the US currency, he said.
The premium will also increase as the US Federal Reserve keeps cutting interest rates to spur growth, widening the gap between US and Indian rates, Agarwal said. The Fed has lowered its key rate six times since September to 2.25% as financial firms wrote down more than $232 billion (Rs9.25 trillion) in losses from subprime mortgage-related loans. “We expect a shallow recession in the US this quarter,” Agarwal said. “The Fed may cut rates by 50 basis points this month, pushing dollar money rates lower.”
A basis point is one-hundredth of a percentage point.
The forward premium on the dollar may also rise as Indian importers buy the US currency to meet payments due in coming months after the rupee fell 1.8% from January through March, the first loss in seven quarters, Agarwal said. A weaker rupee increases the cost of India’s imports.
“The weakness in the rupee may trigger a shift in hedging patterns in the forward market,” Agarwal said. “Importers may want to buy more dollars than supplied by exporters.”