Column: The 22.7-billion-dollar question

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SummaryFCNR swap should be the last resort, not the first option to bolster the forex reserve

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.

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