The U.S. and India interest rate differentials are almost fully incorporated into the current levels, and are unlikely to fall much further, analysts said.
The USDINR 1 year implied forward premium plunged nearly 50 basis points bps in November to 1.88% - its lowest in over a decade - mainly due to the shrinking U.S. and India interest rate differentials.
The 1 year rupee overnight index swaps declined by about 30 bps in November, which was helped by a better outlook domestically that prompted traders to lower their expectations on the Reserve Bank of India's terminal rate.
The 1 year U.S. SOFR secured overnight financing rate linked swap increased in early November after the Federal Reserve Chair signalled a higher terminal rate.
The difference between the two rates has dropped to about 1.85%, near the 1 year USD INR premium level.
Abhishek Goenka, CEO of IFA Global said the forward premium is now in line with interest rate differentials. He said that there was little downside for USD INR premiums from here.
There seems to be some 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.
The RBI's activity in the forward market has contributed to the fall in premiums, as well as interest rate differentials.
A trader at a large private sector who did not want to be identified, said that 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.
The RBI buy sell swaps are likely to change its forward book once the RBI stops its operations in forwards, and premiums will move higher, the trader said.
Near-term implied yields are lower than the far forwards and are below the current overnight USD INR swap rate. The December premium is at 0.35 to 0.37 paisa per day compared to the 0.43 cash swap rate.
The RBI's operations matter on shorter timelines. Abheek Barua, chief economist at HDFC Bank, said that premiums should reflect interest rate differentials.
There is a belief 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%.