FCNR (B) redemption unlikely to impact bond, currency markets: Ind-Ra

The foreign currency non-resident bank account FCNR (B) deposit redemption, which begins in September 2016, is unlikely to be disruptive for the bond and currency markets, according to India Ratings and Research (Ind-Ra).

The credit rating agency expects the impact of this large redemption to be absorbed by the system with support from the Reserve Bank of India since the maturity, timing and quantum of these deposits is certain and palpable.

However, Ind-Ra believes external factors can create tail-end risks. Indian banks had raised $26 billion FCNR (B) deposits between September-November 2013 and that is scheduled to start maturing from September 2016 onwards.

During 2013, the RBI introduced a new FCNR (B) deposits scheme to accumulate foreign currency due to the worsening balance of payment conditions. The RBI offered a special window to the banks to swap the fresh FCNR (B) dollar funds, mobilised for a tenor of three years to five years at a fixed rate of 3.5 per cent annually for the tenor of the deposit.

The total amount raised through the FCNR (B) window was $25.97 billion, additionally $8.35 billion was raised through banking capital. Due to the nature of such a planned scheme with a known maturity, the RBI has hedged the entire transaction so as to create a smooth transition.

OMOs Will be Positive for Bond Markets

Ind-Ra said RBI is likely to step up its open market operations (OMOs) to manage the likely liquidity shortfall on account of the FCNR (B) redemption.

It assessed that with the possibility of regular foreign assets (net foreign assets) accretion getting impacted  due to a combination of usage of US dollar from exports and/ or depletion of forex, these are likely to be replenished by accumulating domestic assets (net domestic assets) in sync with the requirement of domestic money supply.

However, the quantum could vary based on the balance of payment position and thus may necessitate additional OMOs.

Multiple Tools to Manage Rupee Liquidity

In Ind-Ra’s view, RBI will keep systemic liquidity at ease and additionally could consider a combination three options — arrange for a sizable amount of higher tenor term repo; followed by OMO purchases; and reduction in daily cash reserve ratio maintenance from 90 per cent to 70 per cent of the net demand and time liabilities for the stipulated period.

Further, FCNR (B) redemptions will not have an impact on statutory liquidity ratio and cash reserve ratio requirements, but can cause a dip in bank deposits. Any uptick in money market rates is likely to be transient and limited.

Options for Redemption Payments

Besides the swap arrangements and forex flows from exports, RBI can utilise the foreign exchange reserve, which stands at $363 billion as of April 29, 2016. Additionally, RBI can also use the line of credit arrangement with other central banks, said Ind-Ra. 

RBI signed an agreement with Bank of Japan in September 2013 for the swap amount of $50 billion to address possible short-term liquidity mismatches. Ind-Ra believes that India can also add another $10 billion to its forex reserve by September, contingent upon stable global conditions.

Tail-End Risks from Global Markets

The rating agency observed that challenges, however, may arise in the event where exporters are not in a position to deliver the requisite US dollars to banks, which have entered into a swap agreement with RBI or if there are timing mismatches between various SWAP transactions with different sets of counter-parties.

The maximum redemption is limited to $26 billion plus interest, most of which will mature between October and November 2016. The rest will mature thereafter but before 2018. 

Tail-end risks, however, cannot be undermined due to the worsening global environment caused by the China slowdown and/ or unexpected Fed tightening, resulting in a flight to safety. In such a case the impact will be more severe on the US dollar/Indian rupee, a spill-over of which can impact both the debt and equity markets.

COMMENT NOW