With limited scope for rollovers, the forthcoming FCNR-B deposit redemptions beginning September through November will lead to increased volatility in the money markets due to maturity mismatches causing wild swings in forex reserves and therefore the rupee, says a report.
The redemptions will also lead to hardening of the call money rates, forcing RBI to conduct more open market operations to curtail rupee volatility and increase liquidity in the market as these deposits account for around 1.8 per cent of total deposits in the banking system.
“Though the RBI has been making the right noises about being adequately hedged for the FCNR (B) deposits maturity in September-November, the high risk of maturity mismatches will lead to swings in forex reserves and therefore rupee liquidity as there is limited scope for rollover since as much as 85 per cent of these deposits came in from leveraged funds,” said the report by Kotak Securities.
Consequently, there could be significant pressure on the rupee and liquidity, prompting RBI to conduct more OMOs. This should be positive for bonds, but money market rates may harden as banks struggle to raise deposits, it warned.
The September-November period is expected to see forex outflows of around USD 25 billion of FCNR-B deposits which were raised and swapped with the RBI under the discounted swap window in 2013 at 3.5 per cent against the then prevailing rate of 6.5 per cent.
These funds were raised after the rupee sniffed at 67.85 to the dollar after the US Fed’s taper talk in May 2013.
This special measure by the RBI had attracted USD34 billion of capital inflows with USD 8 billion raised under banks’ foreign currency borrowing eligible under tier-1 limits and the remaining USD 26 billion under the FCNR-B deposit scheme. As much as USD 25 billion of the total USD 34 billion were had 3-year tenure.
This will have the RBI providing for USD 25 billion on maturity leg of FCNR deposits swap. Of this, USD18 billion will come in November, and lead to similar dip in the forex kitty, which as of May 27 stood at USD 360.2 billion.
“Despite being adequately positioned to tide over its liability, we estimate that RBI’s forward position is likely to be net short by USD 9.5 billion during September-November.”
This is so because RBI, instead of rolling over the forwards to match the maturities, has of late been taking delivery of its long forwards, optimising on stability in global risk sentiment, said the report.
“But if this trend continues, it will help RBI boost the forex reserves to prepare before the eventual payout.”
“Come September-November, we anticipate the banking system facing bouts of dollar shortages as exporters generally deliver only a part of their contracts and roll over the rest,” said the report.