MUMBAI, Jan 29 (Reuters) - Expectations of the rupee depreciating further are spilling over into India's rates market, with speculative offshore and hedging flows pushing up FX forward points and having a knock-on impact on local interest rate swaps.
The rupee's slide from 2025 has carried into January, with the currency repeatedly setting fresh record lows. At the same time, one-, two- and five-year overnight indexed swap (OIS) rates have risen to multi-month highs, underscoring broad-based pressure despite benign inflation and little prospect of policy tightening.
Sustained capital outflows and high U.S. tariffs are pressuring the rupee, compounding stress in India's OIS market, already strained by a government bond selloff driven by heavy debt supply, volatile developed-market yields and fading expectations of rate cuts.
The stress on the rupee is lifting FX forward points, reflecting rising hedging demand.
There is a strong correlation between FX forward points and OIS, especially during upward moves, said Tanay Dalal, senior vice president, business and economic research at Axis Bank in Mumbai.
The correlation explains why the OIS curve is pricing in at least 50 basis points of rate hikes over the next two years, and "more shockingly" around 25 bps of increase within six months despite controlled inflation and ample liquidity, he said.
While FX forward points capture the cost of hedging in currency markets, OIS is a gauge of interest rate expectations.
STUBBORN FX FORWARDS
Dollar/rupee forward points across 1 to 3-year tenors have risen this month despite the Reserve Bank of India conducting a 3-year $10 billion buy/sell FX swap and announcing another operation next week. The central bank has additionally been using buy/sell swaps to sterilize its spot dollar sales.
Typically, these operations exert downward pressure on FX forward points. Bankers say the fact that forward points continue to rise indicates persistent hedging and speculative appetite linked to expectations of further rupee depreciation, which is feeding into OIS rates.
"The sudden move in dollar/rupee from 89 to 92 over two months has significantly boosted hedging interest from importers, foreign currency borrowers and foreign investors, resulting in FX swap points ... trending higher," said Sameer Karyatt, executive director and head of trading at DBS Bank India.
The pace of the rupee's decline has accelerated. After falling nearly 5% in 2025, the currency has already lost about half that amount in January alone, hitting a record low of 91.9850 on Thursday.
Analysts are taking note, revising their rupee forecasts. Goldman Sachs expects the rupee to weaken to 94 over the next 12 months, versus its previous forecast of 91.
"FX problem is becoming a rates problem," said the head of trading at a private-sector bank, who did not want to be named since he is not authorised to speak to the media.
A lack of clear catalysts to draw foreign inflows, as well as recent RBI comments that an annual decline of 3%-3.5% versus the dollar is typical for the rupee, have reinforced expectations for further depreciation, the banker said.
The rupee's persistent struggles and spillover impact on the rates markets mean the central bank may need to extend its reliance on swap operations to keep forward premiums in check, analysts say.
FX swaps have taken on the additional role of helping manage market pressures surround fast depreciation of the INR - which have been spilling over into domestic monetary conditions - in addition to their purpose on liquidity management, Axis's Dalal said.
(Reporting by Nimesh Vora, Jaspreet Kalra; Editing by Ronojoy Mazumdar)
By Nimesh Vora and Jaspreet Kalra
