The rupee is expected to resume its downward journey soon
In early September this year, when the Indian currency was on a decline, and was hitting the nadir, the Reserve Bank of India introduced a dollar-rupee swap window for fresh fcnr (b) dollar funds – mobilised for a minimum tenure of three years and above and with one year lock-in at a fixed rate of 3.5 per cent per annum. The swap facility is available for fresh fcnr (b) deposits mobilised in any permitted currencies, which includes pound Sterling, Australian dollar, Canadian dollar, Japanese yen, US dollar, etc.
The main feature of FCNR (b) deposits is that the depositors do not have to face the currency risk, as it is borne by the banks. Earlier, banks opting for FCNR (b) deposits were shying away from converting foreign currency into Indian rupee as they had to bear the currency risks. The introduction of swap window by the RBI at a fixed rate of 3.5 per cent will help the banks to lock in their cost of the deposits and invest the rupee amount at higher rates.
RBI also raised banks’ overseas borrowing limit of 50 per cent of unimpaired Tier i capital to 100 per cent and the borrowings mobilised under this provision can be swapped with the RBI at concessional rate of 100 bps (basis points) below the ongoing swap rate. These schemes will remain open till 30 November 2013. Last month, RBI freed interest rates on FCNR deposits of three-to-five-year duration, to attract more funds from non-resident Indians (NRIs) and persons of Indian origin (PIOs). Indian banks are now offering interest rates ranging from 3.95 per cent to 4.95 per cent on FCNR deposits (mobilised in dollars) for FCNR deposits of three-to-four-year duration and from 4.77 per cent to 5.77 per cent for five-year deposits.
These moves are expected to achieve multiple objectives. Firstly, it will attract dollar funds from the NRIs, which will bring the much needed foreign exchange into the country at a time when Indian currency has depreciated significantly. This move is expected to strengthen the Indian currency in the near term – or at least prevent a further slippage.
Several foreign banks overseas are even providing upfront financing (leverage) to their high net worth NRI clients to encourage higher dollar deposits in India. The leverage provided by these foreign banks is as high as nine times the investments made by the depositor. The NRI depositor makes just 10 per cent of the total deposit amount and the balance is funded by the foreign bank. The return earned by the investor on such deposit (self-contribution) is as high as 20 per cent. Market experts believe this move could bring $10-30 billion of foreign exchange in India in the next few months.
Secondly, such huge inflows of foreign currency in India in a short span of a few months is expected to give much-needed breathing space for the Indian government, that would have otherwise required them to raise funds through issue of sovereign bonds at the time when India stands the risk of sovereign downgrade.
Thirdly, it will help Indian banks to get funds at cheaper rates of about 8.45 per cent (3.5 per cent rate fixed by RBI plus 4.95 per cent interest on FCNR deposits), as compared to the prevailing higher CD rates. They can swap dollar with Indian currency at a fixed rate of 3.5 per cent and use this money to lend at higher rates in India.
On the face of it, this entire arrangement looks like a win-win situation for all participants. However, there is a reason to believe that this is just an illusion and the benefits from this scheme will be temporary in nature. As various lending banks and borrowing banks have put their internal limits towards exposure to this scheme, the amount of foreign exchange inflows through these levered FCNR (b) deposits will be at the lower end of the anticipated inflows of $10-30 billion. This will restrict the inflow of what is essentially hot money into the system through this route.
This inflow of hot money will only provide temporary relief and not solve the problem of funding deficits on the sustainable basis. Once the tenure of this scheme is over, Indian currency will again resume its downward trajectory.
Also, the foreign debt of Indian corporates to the tune of $33 billion is set to mature by March 2014. This will exert pressure on the Indian currency once the scheme ends in November 2013. So, while experts believe this move by the rbi will provide support to the Indian currency in the near term, we believe fundamentally strong measures will have to be taken by the government to attract long term funds on a sustainable basis.
This article was originally published in Business India Magazine.
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