FCNR redemption: Swelling coffers, rising confidence

Allaying concerns over the volatility that may hit the exchange rate and rupee liquidity come September, when the foreign currency non-resident (FCNR) deposits raised in 2013 come up for redemption, the RBI governor assured that the central bank has sufficient dollars in its coffers to meet eventualities.

The opening of the special swap window in September 2013 helped banks mobilise about $25 billion of FCNR (B) deposits. But given that a chunk, nearly $20 billion of such deposits, was ‘borrowed’ (leveraged) money, these are not expected to be rolled over. This had raised doubts on whether the RBI is well prepared to cover these outflows.

The RBI opened a special window for swapping FCNR (B) deposits mobilised by banks in September 2013. Banks could swap these dollar deposits, mobilised for a minimum tenor of three years at a fixed rate of 3.5 per cent per annum as against the then hedging cost of about 7 per cent. When the RBI bought dollars from the banks and sold rupees in the swap, it was with an agreement that the transaction would be reversed at a later date (when the deposit matured) at predetermined rates. By subsidising the swap cost, the RBI made it viable for banks to channel funds through this route. How? When a bank mobilised dollars through NRI deposits, it had to pay LIBOR plus 400 basis points on such deposits. If the hedging cost to convert these dollars into rupees was about 7 per cent, the effective cost of funds was upwards of 12 per cent. With the then minimum lending rate (base rate) hovering around 9.5-10 per cent, this was hardly feasible for banks. With the RBI subsidising the hedging cost at a fixed 3.5 per cent, the effective cost of funds came down to 8.75- 9 per cent, similar to the cost of raising domestic deposits.

Depositors gained too, thanks to the leveraged nature of the product.

Here’s how. Say, an NRI deposited $1,000 in an overseas branch of an Indian bank; he got an overdraft of $9,000 on the deposit. This was on the condition that the total $10,000 was deposited into the Indian branch of the bank as FCNR (B).

The bank paid the depositor interest on the $10,000 deposit at LIBOR plus 400 basis points for three years. On the other hand, the bank earned interest on the amount they lent in India ($10,000 converted into rupees) as well as on the overdraft ($9,000) given to the depositor overseas. Economists reckon that the scheme delivered an annualised return of close to 10 per cent for the bank and about 17-18 per cent for the depositors.

Given that much of the FNCR (B) deposits were raised through the leveraged route, these are unlikely to be rolled over in September 2016; so, there could be huge outflows. But the RBI seems well prepared for this.

As of March 2016, the RBI’s net forward dollar position was negative $4.25 billion, down from a negative $32.5 billion in November 2013. This suggests that the RBI has taken forward purchase contracts during this period, to cover expected outflows from its sales contracts. That said, the RBI acknowledged the risk of some volatility as some counterparties may not be able to easily deliver on the dollars they owe. Even so, it assured the market of handling the situation by supplying dollars, if the need arose.

Over the past three years, the RBI has been bolstering its foreign exchange reserves, which are now a healthy $363 billion (up from about $280 billion in November 2013). 

The resultant squeeze on rupee liquidity, will also be adequately addressed, the RBI has said.