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There has been much focus in recent days on the FCNR-B deposits, the so-called “time bomb”, with concerns about the outflow of USD 26 billion of NRI deposits maturing from September to December 2016. The Reserve Bank of India (RBI) has sought to assure the markets that the outflow, which it estimates will be to the tune of US $ 20 billion, will be addressed in a non-disruptive manner but market sentiment continues to be governed by the fear of a speculative attack on the rupee.
As a result, it has brought the RBI into the headlines in a manner that is neither comforting for the central bank nor does justice to the fairly strong fundamentals of the Indian economy at this stage. Equally, it miscomprehends the FCNR-B scheme itself, which was launched three years ago at a time the economic indicators were very different.
The scheme dates back to 2013, when inflation was high and growth was weak. The Current Account Deficit hovered around five per cent, which was in itself an all-time record. Global conditions were murky, with oil prices having seen none of the slide then. European markets were unsettled. The announcement of the tapering of the economic stimulus provided by the US Federal Reserve fueled fears of a dollar outflow from emerging market economies like India, causing the so-called “taper tantrum”. The period can be considered one of the dark phases in India’s economic situation in recent years.
The rupee, already depreciating, came under speculative attack, capping what was a perfect storm that made for an ominous welcome for the then new Governor. The impact can be gauged from the fact that the rupee reached an all-time low hitherto of Rs.68.36 to the US dollar on August 28, 2013, with wild speculation that the currency would fall to Rs.70 and beyond.
It was in these circumstances that Dr. Rajan entered his 18th floor office in the RBI headquarters building and took charge as the Governor, moving from the role of an advisor in Delhi to what many regard as the sole decision maker in the RBI. And he decided to act.
A large portion of the deposits will be withdrawn in the September-November period, since NRIs who borrowed to invest will not renew. This will lead to a burst of outflows of the order of $20 billion or so, clearly a large outflow and in some senses unprecedented. There is also the question of intra-day volatility during the three month period of withdrawal since the deposits mature on different days, leading to likely mismatches and market concerns on volatility on that count.
On September 4, 2013, which was the very day he took over, the RBI launched a scheme that incentivised banks to raise dollar deposits from NRIs. The deposits were to be for a minimum period of three years. This was the Foreign Currency Non Resident, or the FCNR-B scheme, where the B stood for banks.
In a scenario where the rupee was weakening and the costs of hedging the dollar positions was rising, banks would not be keen on raising NRI dollar deposits. The RBI made it attractive however by offering its swap window for a fixed cost of 3.5% per annum specifically for fresh deposits from NRIs and new overseas borrowings of banks. This capped the hedging costs for banks, which went out to raise the dollars, which were swapped on the RBI concessional window, with the rupee proceeds deployed at higher rates. The NRI depositor was offered well-above market rate (400 basis points above the London Interbank Offer Rate, or LIBOR) and carried no currency risk. Many NRIs borrowed to invest in the scheme, given that it offered robust returns. The interest rate arbitrage was too attractive to be missed.
The scheme remained open from September 10, 2013 to November 30, 2013. It led to a significant rise in NRI deposits with inflows of US $34.3 billion, of which about US $26 billion was mobilised through fresh FCNR-B deposit swaps with the banks.
The scheme met its immediate target – mobilising US dollars swiftly at a critical time to support the rupee, pushing back on the speculative attack and signaling to the market that the RBI would use all routes to arrest the slide in the currency. This was achieved but at a very high cost to the RBI. There are no numbers but it is estimated that the cost to the RBI could be as high as USD one billion per year.
As the dollars flowed in to the RBI kitty, the RBI further sold these with a forward cover to public sector banks. Now, as the dollars are called back, there is the possibility that the counterparties of these banks, mostly exporters, will not be able to pay back. However, this cannot go on forever because the counter parties have to eventually pay for their borrowings.
In any case, a large portion of the deposits will be withdrawn in the September-November period, since NRIs who borrowed to invest will not renew. This will lead to a burst of outflows of the order of $20 billion or so, clearly a large outflow and in some senses unprecedented. There is also the question of intra-day volatility during the three month period of withdrawal since the deposits mature on different days, leading to likely mismatches and market concerns on volatility on that count. Such volatility due to the shortage of rupee liquidity could be handled with the Open Market Operations (OMOs) conducted by the RBI.
The RBI must ensure that this process is smooth. In this light, the RBI put out its assurance: “There may be some episodes of dollar shortage in the market going forward. It is something we will monitor, we may supply dollars in case of extreme volatility but no one should take this for granted. We have plenty of dollars that we can supply if necessary. We are also committed to supply short-term rupee liquidity to the extent needed to support our monetary stance.”
What the governor was saying is that they will not bail out anyone but will also not allow any disturbance in the system. While the situation will need careful monitoring, it is hardly the ticking bomb that it has come to be called.
The question to be asked is simple: Is the regulator prepared and ready to meet the situation? At this stage, the RBI’s clear message is that it is on top of the situation.
(Dr. R.K.Pattnaik is Professor at SPJIMR. Jagdish Rattanani is Editor SPJIMR)