Dark clouds are gathering on the horizon of the external sector of the country. The trade deficit during 2011-12 was at $185 billion, the highest ever. Foreign currency assets of the Reserve Bank of India (RBI) are adequate to finance around six months of imports only, against 11 months at end-March 2010. The situation is further aggravated by developments in external debt. The rupee is on a steep depreciating path. The global trends, particularly those relating to the US and Europe, are not encouraging either.

Strengthening balance of payments

My article “Wooing NRI deposits makes sense”, ( Business Line , January 2) made the following recommendations for strengthening the balance of payments:

At $34 billion, gold accounted for around 10 per cent of total imports in 2010-11 and it was time to discourage it by enhancing the customs levy; and

Interest rates on the foreign currency non-resident (FCNR) account denominated in dollar and other selected currencies be deregulated, as in the case of the rupee account.

Subsequently, the Government raised the customs duty on gold from Rs 300 per 10 gm to 2 per cent on January 17 and 4 per cent in the Budget, besides increasing the duty on silver.

According to press reports, there is a declining trend in the import of gold since then. Besides the duty, the depreciation of the rupee is a discouraging factor. A further rise in the duty to 5 per cent may be considered later after the Budget is passed. Enhancement of tax/duty is not permitted in the Budget discussion. There need not be any fear of smuggling and hawala transactions being resumed.

Unlike in the past, the international price is high and money-laundering measures should be enforced to prevent the illegal import of gold.

At around Rs 2,820/gm ($1650 per troy ounce) abroad, Rs 2,851/gm in Mumbai and Rs 53.50/$, there is not much incentive for smuggling. Gold prices may remain high in the international markets during the rest of the year, unless the US/European economic crises are resolved.

As for the second recommendation, the RBI has raised the margin on the interest rates of FCNR Accounts over LIBOR/Swap for the terms deposits of one-less than three years and three-five years, from 125 basis points (bp) in the case of both to 200 bp and 300 bp, respectively. The banks generally have the same rate structure for the resident foreign currency (RFC) account as for the FCNR Account.

Freeing foreign accounts

The RBI should go the whole hog and completely free the two accounts from control. There are NRIs who have returned to India and opened RFC accounts and transferred a part of their balances from abroad. It will be an incentive to them to bring more funds to India, if the rates are attractive.

The RBI's disinclination to free the foreign currency account from rate regulation is, perhaps, the outcome of its experience in the Gulf Crisis of the 1990s. At its height, the central bank exempted non-resident deposits from cash reserve and statutory liquidity ratios and gave freedom to banks to fix the rates. There was an intense competition among banks.

As a result, there were considerable arbitrage operations, particularly in the Gulf area. Banks there were reported to have encouraged NRIs to borrow from them at lower rates and deposit the funds in India with a share in the spoils.

A serious problem arose when the economic situation deteriorated. The Gulf banks recalled the loans given to NRIs who, in turn, closed their deposits in India prematurely, thus aggravating the forex crisis through the haemorrhaging of reserves. The RBI had to prescribe a ceiling on the daily transfer of funds abroad. But, now, the situation is different. The exchange risk is borne by the depositor/bank in the case of rupee/forex deposits, unlike in the earlier episode when it was the RBI.

There is no exemption from CRR and SLR for NRI deposits. The lending rates in the US for consumer loans range between 6 per cent and 8 per cent for periods between three and five years.

Banks can fix the rates of interest on term deposits that are attractive in contrast to the low levels in the West but, at the same time, would not facilitate arbitrage. The NRIs have enormous wealth.

Stopping rupee slide

The RBI allows foreign currency loans out of FCNR (B) deposits as pre-shipment credit in foreign currency (PCFC)/Rediscounting of export bills abroad (EBR) to exporters and other entities.

A similar permission may be given to banks for other purposes also so that customers need not resort to external commercial borrowings (ECBs). The banks can extend forex loans to the corporate sector for the import of plant and machinery on better terms than ECBs.

The RBI can even think of a refinancing facility for the banks in this connection. This will result in a more profitable utilisation of its reserves than investing in other countries at low yields. Further, when repayments take place, the forex will return to the RBI unlike in the case of market intervention to stabilise the rupee where reserves are lost. In fact, if these suggestions are accepted, there is a possibility of a stop to the slide in the fortunes of the rupee.

It may even appreciate vis-a-vis the dollar. Besides the other advantages mentioned above, the availability of forex loans from our banks will help decelerate the growth of external debt owed to parties other than the NRIs.

(The author is a Mumbai-based economics consultant.)

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