Surplus liquidity had a sobering effect on the forward premia across tenors during the flexible inflation targeting regime with greater uncertainty hardening the forward premia, noted an Reserve Bank of India study.
Regression analysis suggests that surplus liquidity has a sobering impact while greater uncertainty hardens the forward premia, more so in the short term, according to a study titled "What Drives the Forward Premia – An Analytical Perspective" published in its latest monthly bulletin.
Using a machine learning technique and based on monthly data since 2010, interest rate differential, global policy uncertainty, domestic banking system liquidity and RBI’s intervention in forward markets were found to be the principal determinants of the forward premia across the term structure in both the pre-flexible inflation targeting (pre-FIT) period and during the FIT regime.
As an indicator of market perceptions on future dynamics of the foreign exchange market, the forward premia plays a key role in conveying signals to both market participants and the .
The study noted that forward interventions have a positive impact, particularly on the near-term forward premia while surplus liquidity has a sobering effect across tenors during the FIT period. Greater uncertainty hardens the forward premia, more so in the short term. Going forward, the effects of macroeconomic and financial variables on the forward premia needs to be assessed continuously as the findings are sensitive to sample periods and regime shifts.
The results suggest that RBI’s forward intervention has a positive impact on incremental change in forward premia (with varying statistical significance) across the term structure. In terms of magnitude, the highest impact is on the near term (1-month tenor) while the most significant impact (statistically) is on the 12 months tenor.
Banking system liquidity has helped in reducing the forward premia across tenors; the maximum impact being on the near term. An increase in surplus liquidity has resulted in softer interest rates, which, in turn, reduced the interest rate differential, thereby lowering the forward premia.
The RBI’s conventional and unconventional measures after the outbreak of the pandemic have also reinforced this impact by boosting market sentiments, the study said
Regression analysis suggests that surplus liquidity has a sobering impact while greater uncertainty hardens the forward premia, more so in the short term, according to a study titled "What Drives the Forward Premia – An Analytical Perspective" published in its latest monthly bulletin.
Using a machine learning technique and based on monthly data since 2010, interest rate differential, global policy uncertainty, domestic banking system liquidity and RBI’s intervention in forward markets were found to be the principal determinants of the forward premia across the term structure in both the pre-flexible inflation targeting (pre-FIT) period and during the FIT regime.
As an indicator of market perceptions on future dynamics of the foreign exchange market, the forward premia plays a key role in conveying signals to both market participants and the .
The study noted that forward interventions have a positive impact, particularly on the near-term forward premia while surplus liquidity has a sobering effect across tenors during the FIT period. Greater uncertainty hardens the forward premia, more so in the short term. Going forward, the effects of macroeconomic and financial variables on the forward premia needs to be assessed continuously as the findings are sensitive to sample periods and regime shifts.
The results suggest that RBI’s forward intervention has a positive impact on incremental change in forward premia (with varying statistical significance) across the term structure. In terms of magnitude, the highest impact is on the near term (1-month tenor) while the most significant impact (statistically) is on the 12 months tenor.
Banking system liquidity has helped in reducing the forward premia across tenors; the maximum impact being on the near term. An increase in surplus liquidity has resulted in softer interest rates, which, in turn, reduced the interest rate differential, thereby lowering the forward premia.
The RBI’s conventional and unconventional measures after the outbreak of the pandemic have also reinforced this impact by boosting market sentiments, the study said
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