BT Explainer: How a special window to attract FCNR (B) deposits can help bring in more forex

To reverse the heightened foreign institutional investor (FII) outflows from India’s equity markets in the backdrop of the conflict in West Asia, the Reserve Bank of India (RBI) is banking on a measure that has been successful in the past, Foreign Currency Non-Resident Bank, or FCNR (B), accounts.

The RBI hopes that the special window to attract foreign currency deposits from non-resident Indians (NRIs) will bring in much needed foreign currency inflows and ease the pressure on the rupee, which has depreciated significantly in recent months.

What are FCNR (B) deposits?

These are special fixed-term deposits that banks in India can offer NRIs, overseas citizens of India and persons of Indian origin. It helps such people maintain a fixed deposit account in India in freely convertible foreign currencies. Since the account is in foreign currency, the funds are in a way protected from currency fluctuations during the duration of the deposit. The funds and the interest earned on such deposits is tax-free in India.

When and why was such a measure introduced previously?

The RBI had announced such a special window for FCNR (B) deposits back in 2013, when emerging market currencies were under pressure following US Federal Reserve’s announcement that it would begin rolling back its massive quantitative easing bond buying programme, the RBI came out with a similar scheme.

Back then, the RBI offered a window to swap US dollars that banks would raise via foreign currency non-resident (FCNR) deposits of three-year maturity and above at a concessional rate of 3.5%, which was around 3 % cheaper than the market at the time.

Banks were also allowed to raise foreign currency funding and swap them into rupees at a concessional rate. Through these two measures, some $34 billion was raised, which included $26 billion via FCNR (B) deposits.

How will the swap facility work this time?

The swap facility this time will be for fresh FCNR (B) deposits mobilised for a minimum tenor of three years and a maximum of five years. This facility will be available for authorised dealer (AD) category 1 banks for fresh FCNR (B) deposits mobilised in any freely convertible currency. This will include deposits that are renewed upon maturity too. But, the swap facility with RBI will be available in US dollars only.

For FCNR (B) deposits mobilised in permissible foreign currencies other than US dollar, banks may arrive at the equivalent US dollar amount eligible to be swapped by converting the same at the prevailing market rates on the day of the swap deal. Banks would be free to price these deposits as per their internal policy, but within the overall ceiling as per the extant guidelines issued by RBI.

Under the swap arrangement, a bank can sell US dollars in multiples of $1 million to RBI and simultaneously agree to buy the same amount of US dollars at the end of the swap period. The swap facility comes into effect immediately and will remain open up to October 16, for deposits mobilised between June 8 and September 30.

The swap will be undertaken at par. Essentially, the settlement of the first leg of the swap will take place on spot basis, and the second leg of the swap will take place at the same rate as the first leg.

How will banks benefit?

“By absorbing the full hedging cost—bringing effective rates down from around 8% to a competitive 5-6%—the RBI is incentivising banks to mobilise fresh foreign currency deposits,” noted Dhananjay Sinha, CEO and co-head of institutional equities at Systematix Group.  

Importantly, the rates will be lower than the current domestic term deposit rates.

Soumya Kanti Ghosh, the group chief economic adviser at State Bank of India, pointed that longer maturities would reduce rollover risk and enhance the stability.

“A 5-year FCNR (B) deposit provides a longer and more predictable source of foreign currency funding than a 3-year deposit,” he said.

Importantly, with the RBI bearing full hedging cost and also the SLR (statutory liquidity ratio) and CRR (cash reserve ratio) costs till September 30, banks can offer more attractive rates on FCNR (B) deposits without taking unhedged currency risk, according to him.

As per SBI’s research, the current FCNR (B) rate is 3.35% for three-year tenor. Cost of hedging (costs to protect such deposits from exchange rate fluctuations) and forward premium (foreign currency is priced higher for a future rate, compared with the spot market), is around 3.5%. It believes banks can offer attractive FCNR (B) pricing of 5.5 % or higher.

It believes FCNR (B) deposits could easily attract upwards of the levels of $34 billion that was mobilised in 2013.

Madhavi Arora, chief economist at Emkay Global Financial Services also believes with the RBI bearing the full hedging costs, domestic banks will be able to offer 6.0-6.6% rate on FCBR (B) deposits, which will be attractive compared with the 3-5 year rates in the US currently at 4.2-4.4%.