FCNR(B) Flows – After the deluge, comes the liquidity management

The special FCNR(B) window closed with a bang on 31-August. A deluge of FCNR(B) deposits has become a cause for celebration, but the bigger question is how the RBI will handle the deluge of liquidity.

Bigger and better than the 2013 story

If the FCNR(B) window collected around $26 billion in 2013, the 2026 collections stood at $126 billion (growing five-fold). There have been some FCNR routine rollovers and there have also been some deposits that got cannibalized from NRE to FCNR. However, that does not take away from the fact that NRIs have shown great confidence in the Indian economy and infused $127 billion through the FCNR(B) window. Even if we accept the fact that a substantial part of the inflows were leveraged by the banks, it still does not take away from the confidence reposed. That is the big takeaway.

Lot more comfort on forex management

This is, probably, one big change that is going to happen. In the past, the RBI was wary about the extent of intervention as it knew that forex reserves would deplete. That also gave enough leeway for the forex traders to short the rupee in global markets. By the time the swapping of dollars to rupees is completed by 11-Sep, the forex reserves are expected to swell to over $800 billion. That would nearly cover 12 months of merchandise imports. With these levels of forex reserves, the RBI would not have to overly worry about splurging $100 billion to defend the rupee. The very idea of what the RBI can do will keep rupee short sellers on the guard. That is a big advantage.

How to handle the rupee liquidity glut

The dollar part of the story was a lot simpler. The more complex story is how the rupee liquidity is handled. After all, the entire $127 billion would be swapped by the banks for rupees, resulting in an overall liquidity infusion of ₹12 trillion. This will happen in phases till 11-September when the swap window for the FCNR(B) deposits officially closes. How will the RBI handle the liquidity? It will obviously look at a combination of variable rate reverse repos (VRRR) and open market operations to soak up the excess liquidity in the market. Of course, this is well above the RBI proposed liquidity of 1% of NDTL. For the banks, it automatically balances their deposit growth with credit growth!

RBI must plan redemptions more effectively

There is a substantial outflow for the RBI on the FCNR(B) deposits. Over a 5-year period, the approximate cost of the hedge would be $19 billion for the RBI, even assuming a conservative 3% cost per annum. That is a big number to plan for. Then there is the $127 billion redemption at the end of 3-years and 5-years; with most bunched at the end of 5 years. In the last 3 years, the RBI paid out nearly ₹7.67 trillion as dividends. It is now time to cushion up the reserve transfers so that it has a safety net for the large redemption pressure. That would mean lower dividends to the government, and a better game plan to manage the redemption and for any unforeseen forex market disruptions.