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Mumbai , Sept. 15

IN a move that has taken both market players and bankers by surprise, the Reserve Bank of India has further compressed the interest rates on non-resident external (NRE) deposits.

Interest rates on fresh repatriable NRE deposits for one to three years have been reduced to 100 basis points above the LIBOR/SWAP rates for US dollars of corresponding maturity from the existing 250 points above LIBOR/SWAP. The revised rates will be effective September 15.

The RBI decision is seen as an effort to weed out possible opportunities for arbitrage, ahead of the Resurgent India Bonds (RIB) redemptions, which will release $5.5 billion worth of liquidity into the system in October. There are others who see it as an admission on the part of the RBI that it does not have enough bonds to sterilise the liquidity.

Earlier, in July, the RBI had imposed a ceiling of a maximum interest rate of 250 basis points (2.50 per cent) above LIBOR/SWAP.

The RBI decision is expected to hit SBI's plan to retain a portion of the RIB redemption, which is due next month. The bank, which had announced a new deposit scheme, Pravasi Vaibhav for NRI customers last week, will now have to reset its rates, say banking analysts.

The yield on Pravasi Vaibhav is dependent on the interest rates on NRE deposits and the cost of forward cover prevailing on the date of issue. SBI's prevailing NRE rate for deposits with one year to less than two year maturity works out to 3.90 per cent. This will now be lower by 150 basis points. However, the SBI can offer higher rates through its offshore branches.

The central bank's move also comes in the wake of $1.11 billion accretion to the forex kitty in the week ended September 5, pushing the country's reserves to over $87 billion.

According to bankers, an immediate impact of the reduction in the NRE deposit rates could be fall in the value of rupee against the dollar.

"There might be a knee-jerk reaction and we might see a reduction in inward remittances. But that has already been happening since the last clampdown on NRE interest rates in July. What drives the rupee today is largely overseas dollar weakness and FII flows,'' said Mr U. Venkatraman, Head, Forex and Money Markets, IDBI Bank. However, he said, the rupee is unlikely to depreciate much against the dollar though it may receive a jolt immediately.

Another section of bankers feels that the RBI may not be able to contain the excess dollar liquidity in the system by just capping the NRE deposit rates. It might have to resort to additional measures such as another cut in repo rates.

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