FCNR(B) – Are we being too desperate for dollar deposits?

As the RBI rolls out the red carpet for NRIs to bring in their dollar deposits, the million-dollar question is whether India is appearing more desperate about dollars than it needs to be. Actually, that is what it looks like!

Rolling out the Red Carpet for NRIs

The RBI has continuously sweetened the terms and conditions of the FCNR(B) scheme to attract dollar flows from NRIs. Firstly, FCNR(B) deposits are already tax-free in India. Then, the RBI agreed to bear the full cost of forex hedging on behalf of the banks. This allowed the banks to offer more attractive rates of interest, which went up to the range of 6.7%-7.2%. And now comes the biggest sweetener of all. The RBI has allowed the banks to lend to the NRIs, which can in-turn be deposited as NRI deposits. Alternatively, the banks can get the loan funded by a foreign bank and offer them an LC as a guarantee.

Situation is a lot less desperate today

The way the RBI has been rolling out the red carpet for the high-cost FCNR(B) deposits; it betrays a sense of desperation. The truth is that, despite the recent Middle East crisis and FPI outflows, the situation is still quite comfortable. Back in 2013, the forex reserves were closer to $250 billion, which was less than 5 months of imports. Today, it is well above 11 months of imports. Secondly, today, there is a substantial service export cushion, as well as a reserve position closer to $700 billion. Also, the current account deficit had touched 4.8% of GDP in 2013; now it is less than 0.7% of GDP. Today, India is nowhere in the “Fragile Five” and DFIs have enough heft to offset the FPI selling impact.

Fairly huge cost to this desperation

The irony is that this desperation to raise NRI dollar deposits is coming at a fairly huge cost. Firstly, the banks are going to bear two items of costs. There is the hefty interest of 6.5%-7.2% they will be paying on these FCNR(B) deposits. Also, if the banks are giving loans to invest in FCNR(B) or giving L/C, it is an added cost as these loans will be given at less than the average PLR of most banks. For the government, there is the tax of 30% foregone on the interest income. Above all, the RBI bears the hedging cost and also runs the risk of dollar exposure if rupee weakens sharply. If you add up all these costs, the big question is whether it is really worthwhile bearing such a cost for FCNR(B) deposits.

How much funds will this FCNR(B) round garner?

As per early estimates, the scheme could gather anywhere between $50 billion and $70 billion in the next 3 months till the end of September, when the window will close. However, bulk of this money is going to be the arbitrage money, wherein NRIs will borrow at 5.0%-5.5% and park their money at 6.7%-7.2%. That gives them a clean spread of nearly 1.5% with the exchange rate risk fully covered by RBI. That is not a bad deal for the NRIs, and that is exactly the kind of hot money that came into India in 2013 also. As long as this scheme is open, rate hikes are ruled out as that would spoil the economics of the arbitrage game for NRIs. Perhaps, the dollar deluge may come in; but at a steep cost!