Why did USDINR hedge premiums become lower than before ?
Let's start with what Central banks does in FX markets.To curb volatility and undue appreciation, Central bank buys foreign currency. From INR perspective it is "Buy USD/Sell INR" in spot markets. This action creates INR liquidity in system. You cannot do unlimited purchase as it pushes up system liquidity. To stabilize excess INR liquidity, one can use forwards and do a "Sell/Buy swaps" to remove excess INR liquidity. Everyone is aware about India's FX reserves and Central bank's action. Now if you keep on doing "S/B swaps" or paying premiums, it will naturally head higher.
Now too much of higher premiums is also a problem as it attracts more carry trades. So the problem gets more aggravated rather than getting resolved. So rather than market action, you need policy action.
Now understand why banks dont want to hold USD on their balance sheet. Every asset has a risk weight and capital to be set aside. Hence banks do swaps in the reporting month ends.
