Surge in Indian Rupee: Importers Rush to Hedge, Resulting in Increased Margin Costs for Banks

In March 2023, Indian importers made headlines by engaging in foreign exchange hedging with banks at an unprecedented rate, taking advantage of a significant rally in the Indian rupee. This surge in activity has led some banks to face margin calls due to notional losses associated with these positions, as confirmed by several banking professionals.

Surge in Hedging Activity

The total value of dollar/rupee foreign exchange forward contracts purchased by importers reached a staggering $66.5 billion last month. This marks a remarkable 75% increase compared to the previous year and sets a new record for monthly trading volume since the Clearing Corporation of India Ltd (CCIL) began tracking this data in July 2016.

Key Highlights:
- $66.5 billion in forward contracts purchased in March.
- 75% year-on-year increase in importers’ hedging activity.
- Record monthly volume since July 2016.

Contrast with Exporters

Interestingly, this surge in hedging activities stands in stark contrast to the decline seen in forward contracts from exporters, highlighting a significant divergence in market behavior. The impressive hedging was largely influenced by the rupee’s 2% rally in March, bouncing back from its previous record lows. In mid-February, the rupee had plummeted to an all-time low of 87.95, following a 3.5% decline over the prior three months.

As the rupee gained strength in March, helped by a weakened U.S. dollar and increased foreign investments, investors quickly adjusted their strategies by unwinding bearish positions. As of Tuesday, the rupee was valued at 86.07.

Importers Acting Quickly

Given the uncertain outlook for the rupee, importers acted swiftly to secure favorable rates through forward contracts. Many were caught off guard by the rapid decline toward the 88 level, leading to under-hedging as volatility increased. An anonymous FX salesperson shared insights on the situation, stating, “Most importers were not nimble enough to respond quickly, but when the opportunity arose in March, they all jumped in.”

Banks Facing Margin Calls

To manage the dollars traded in the forward market, banks typically offset their positions with other financial institutions. These transactions are cleared by the local clearing house. However, when a bank has a higher proportion of importer clients, it can result in notional losses on outstanding FX forward contracts.

Although the losses are technically the responsibility of the bank’s clients, the clearing house mandates that banks post additional margins to mitigate exposure. A treasury head from a smaller foreign bank commented, “We’ve had to post extra margin to CCIL, primarily due to the high activity from importers.” For larger banks, handling additional margins is a common practice.

An FX salesperson from a major foreign bank noted that their institution had received only a "minor" margin call from CCIL. As of now, CCIL has not provided any comments regarding the situation.

The recent surge in foreign exchange hedging reflects the dynamic nature of the Indian currency market and the proactive measures taken by importers amid fluctuating economic conditions. As the situation evolves, stakeholders in the financial sector continue to keep a close eye on the rupee’s trajectory.