Column: The 22.7-billion-dollar question

Written by Madan Sabnavis | Updated: Nov 27 2013, 08:27am hrs
The biggest success story of our efforts to strengthen the rupee and bring back hope has been the opening of the swap window by RBI on FCNR deposits in September. The latest number of such inflows is $22.7 billion and with the month yet to end, it could move up to $25 billion or even $30 billion. This has been a unique way of garnering dollars for an economy which confronted a shortfall. How has the tune played out and are there any concerns

The concept is quite straightforward. If banks raised fresh FCNR deposits with a tenure of above 3 years, they could give the same to RBI at the existing exchange rate and be assured that when they had to pay back the deposit-holder, they would get it at the same rate with an addition of 3.5% swap rate, calculated on a half-yearly compounded basis. Intuitively, the rupee depreciation for the bank would be 3.5% as against the market swap rate of 7%. Therefore, for any transaction reckoned at say R63/$, the cost at the end would move to R70/$. While this may look like a gamble because the rupee could just appreciate by that time instead of decline, the same deal in the market would have come for around 7%. This was a reason why banks never aggressively marketed this product. This has a dual advantage in that it has helped to get dollars as well as augment deposits which have been used to finance both credit and investments.

The FCNR deposit rate was fixed to LIBOR/swap rate plus 400 bps for such deposits at the upper-end. Therefore, with the FEDAI announced rate being 0.70% for 3 years and 1.4% for 5 years (as of October-end), the deposit rate could go up to 4.7% and 5.4% respectively. Add to this the swap cost of 3.5%, the cost of such funds would be between 8.2-9% with no encumbrance of CRR and SLR. At the base rate of around 10% for the best borrower, banks could still earn 1% return. Therefore, banks have been enthusiastic about this deal since it has straight away added liquidity to the system at a time when domestic deposits are not increasing due to negative real rates and inflation concerns.

This has been a boost to the FCNR deposits which have hitherto not been very popular in the structure of NRI deposits in the country. Out of the $390 billion external debt as of March 2013, long-term NRI deposits were around $71 billion of which only $15 billion was FCNR. NR(E)RA deposits were around $46 billion. Quite clearly, the present deal of offering higher rates and swap has helped banks to market this product. In fact, inflows of FCNR were just $220 million in FY13, indicating that these deposits are not preferred by banks.

Now, what we have done is actually allowed funds to be raised at around 8-9%, with the exchange risk being taken on by RBI in case of depreciation, and banks in case of appreciation. In fact, this is similar to the IMD or RIBS that we had earlier when there was paucity of forex in the country. The difference is that these deposits are being offered by banks and not as bonds by the government (or SBI as it was on the earlier occasions). It is therefore akin to a sovereign bond, without explicit government guarantee.

There are two issues here. The first is that because we are picking up around $25 billion, it adds to our external debt which will cross $400 billion through this measure. But funds through this route sound more dignified and not desperate as a sovereign bond or loan would. The second is that at the time of redemption, there will be a provision that has to be made, as it is unlikely that RBI will roll over this swap, which means that banks will not be willing to go ahead with this scheme as the risk will be on them unless, of course, the rupee appreciates. Earlier, when we went in for RIBs or IMD, they got rolled over into FCNR deposits as the holders of these bonds were NRIs. Therefore, in a way we have postponed the problem and the assumption is that we will have surplus dollars to pay back these deposit holders.

An interesting outcome is that while there is talk of all these dollars coming in, which quite clearly should be fresh money unless other accounts like the NR(E)RA, which is the dominant form, have gotten swapped for these deposits. But, where have these dollars gone While it is true that the data points for these receipts and RBI information on forex reserves is available till November 15 at the moment, our foreign currency reserves increased from $246 billion on September 3 to $249 billion on October 4, and $256 billion on November 15. This is the time period when our trade deficit has come down sharply and FII flows, in net terms, have turned positive. If all this money was fresh, then these reserves should cross $270 billion by the end of the month taking our forex reserves closer to $300 billion mark. This will take us back to the FY11-FY12 days when these levels prevailed.

The swap window has been a smart move in the short-run as it has gotten the dollars without affecting the financial flows of the government. RBI is subsidising this deal by paying up the balance 3.5% on the swapthe cost is around R5,500 crore to R6,500 crore depending on inflows of $25-30 billion. On the other hand if the rupee strengthens, banks will have to bear a cost, unless RBI decides to waive it. Should this be a policy for the future Probably not, as we are tinkering with the markets which should ideally not become a habit. It should be the last resort, but never be the first option.

The author is chief economist, CARE Ratings. Views are personal