FCNR(B) Deposits – A slow start, and the leverage carrot is not helping

The FCNR(B) deposit scheme launched by the Indian government to attract NRI flows and stabilize the rupee has taken off on a tepid note. Against the target of $70 billion, just about $5 billion have been collected; that too predominantly by SBI.

How the red carpet is being rolled out for NRIs

To be fair, the RBI has literally rolled out the red carpet for NRIs to invest in FCNR(B) deposits. To begin with, the currency risk will be entirely borne by the RBI and not by the individual banks. That means; the banks can now offer NRIs the same rate of interest as regular NRE / NRO deposits, since RBI is sponsoring the currency risk. Most banks are offering close to 7.2% on an average. Secondly, the RBI has permitted leverage, wherein banks can lend to NRIs to invest in FCNR(B) deposits with no upper limit. Thirdly, the interest earned on FCNR is tax-free, so effective yield is much higher.

Why comparisons with 2013 are faulty

The normal analogy that is drawn for the current FCNR(B) scheme is with the special scheme launched under Raghuram Rajan in 2013. Back then, Indian forex reserves had depleted rapidly, rupee was falling vertically, and current account deficit stood at 5%. The FCNR(B) scheme and the FCCB scheme jointly collected $35 billion. Hence, the RBI had projected inflows at $70 billion in 2026. However, the big difference is the yields. Back in 2013, the world was recovering from the global financial crisis and the rates were closer to zero in global markets. However, with the US bond yields in the range of 4.5% to 4.7%, even the 7.2% yield is not attractive if you factor in the country risk.

There are also structural issues involved

While the comparative yields are a big reason, even the practical implementation aspects are making a big difference. For instance, the idea is to structure the FCNR(B) deposit flow through the IFSC in Gujarat. However, that is easier said that done and; structuring it takes a lot of time. RBI has only given a 3-month window to complete the FCNR(B) deposit mobilization process. There are also challenges around leveraged structures. That is yet to be fully addressed. Above all, the investors have concerns about the fragility of the Indian economy, if the Gulf crisis was to get worse. Not to forget; the crisis in the Middle East has dented the ability of Indians stationed there to park their surpluses in India.

Barclays suggests toning down expectations

According to a Barclays report, the RBI target of raising $60-70 billion may be too optimistic. Barclays believes that $25 billion to $30 billion would be a more realistic estimate of the funds that will come through the FCNR(B) scheme. One way the yields can be made more attractive is for the RBI to hike the repo rates, but that could have a dampening effect on growth, at a time when nominal growth is already under pressure. The government may not be too keen on rate hikes at this juncture. The real deciding factor will be how long the war in the Middle East lasts; or rather how long Trump wants the uncertainty continue in the West Asian region. That is the big question!