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ARTICLE AD BOX
Summary
It’s a well formulated scheme. The central bank will cover the exchange risk that banks otherwise bear if they hold NRIs’ dollar deposits, even if their rates are capped while debt yields abroad are high. Could the yen carry trade help?
India’s foreign exchange position has not looked vulnerable lately. This found emphasis in the Reserve Bank of India’s (RBI) monetary policy statement last week, which noted that its forex reserves covered around 11 months of Indian imports.
Yet, it opened a new window to attract foreign currency non-resident (FCNR) deposits. RBI said it would bear the hedging cost on these FCNR (B) deposits that banks raise. This move to attract foreign currency echoes what was done during the taper tantrum of 2013, but its zero swap cost sets it apart.
Let us look at the terms laid down.
For the period up to 30 September, banks can raise FCNR (B) deposits for tenures of 3 to 5 years. There will be no requirement to carve out reserves from these under the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) provisions once converted to rupees.
Therefore, these funds bear no regulatory cost.
The money can be parked with RBI at the spot exchange rate; after 3 years (or 5), when the deposits have to be returned, banks can take those dollars back by paying the same amount of rupees they got when they parked the funds with RBI. This way, banks do not need to hedge the risk of rupee depreciation; the current forward market rate of around 3% indicates that this is what they save as their hedging bill.
The move is a masterstroke for two reasons. First, rupee liquidity gets injected in the system and banks can lend more. Second, RBI’s reserves rise, thanks to the forex that comes in. But how much of it will come?
The scheme is open to non-resident Indians (NRIs) who have not found such deposits attractive so far. Last year, less than $1 billion flowed into FCNR (B) deposits. But the 2013 scheme drew around $30-35 billion and the latest one, as some analysts and economists reckon, could achieve inflows of anywhere between $20 billion and $50 billion.
These deposits are not taxed. Hence, for the depositor, the rate of interest is all that matters. RBI caps the rate that can be offered at 350 basis points above the alternative reference rate (ARR), which in this case is the secured overnight financing rate (SOFR). Presently, the SOFR is around 3.60-3.65%. Hence, the maximum rate on offer can go up to 7.15% or so. It may be lower, depending on the judgement and requirement of each bank.
The money will get locked in for 3 to 5 years. Interest rates usually change during a deposit’s tenure, which must be factored in by banks as they work out the cost to be borne before they make their special offer.
According to RBI data, banks’ weighted average term deposit rate was about 5.8% in March. This does not account for the CRR-SLR pre-emption that works out to 30-40 basis points. This leaves banks with about 100 basis points (7.15% minus 6.10-6.20%) for a premium rate to attract FCNR deposits. Such long duration deposits have not been favoured much by the system, given hedging costs; with these covered by RBI now, banks have begun upping rates.
The response of the counterparty is the most critical element here.
First, NRIs need to have investible funds to put in. So, their income levels abroad matter. A higher rate than what they can get there would entice them, but what money they put in will depend on how they are faring at a time of global employment and income challenges.
Second, the interest rate structures of FCNR (B), non-resident external (NRE ) and non-resident ordinary (NRO) deposits need to be compared. As of now, the latter two constitute around 80% of total NRI deposits. If there is a swap from these accounts to FCNR deposits, then the gain would be less.
Third, the structure of interest rates in other regions and the expectations of interest rate movements are important. The US Treasury today offers about 4.5% on a five-year bond. A fixed deposit (certificate of deposit) in a US bank can yield around 4-4.5%. An investment-grade bond can offer a 5-5.5% return while a higher rated bond would offer a rate that’s lower by 50-100 basis points. But the Federal Reserve is likely to raise US interest rates, which can push up these yields.
NRIs are likely to weigh these options against what Indian banks offer on FCNR deposits.
Fourth, large investments in debt assets tend to come from those who indulge in some kind of carry trade—borrowing cheap in a foreign market and putting that money in the FCNR (B) deposits that provide higher returns. This way, there is a clean profit to be made without using one’s own funds.
Such money may not be easy to attract these days, as personal loans could start at 6% in the US, depending on one’s credit score and the security being provided. But since interest rates in Japan are low, one could borrow in yen at interest rates as low as 2-3%, convert the money to dollars (which will then be swapped) and hence make a good margin.
Admittedly, any movement in the yen’s exchange rate can negate earnings when the deal is unwound. All the same, we could attract large quantities of deposits from those in the carry-trade business.
Overall, RBI’s move to open a limited window to attract NRI deposits is commendable. It comes at a time when India has comfortable forex reserves and fits well with the rest of RBI’s package, which has incentives for external commercial borrowings and FPI investments too. In all, this is a plan that will surely draw foreign currency. But how much is still a matter of conjecture.
These are the author’s personal views.
The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’
English (US) ·