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All you wanted to know about FCNR (B) outflows

GURUMURTHY K | Updated on March 09, 2018 Published on September 12, 2016

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The Indian currency market has been on tenterhooks lately. It has been bracing for foreign currency outflows as the three-year foreign currency deposits held by Indian banks, which were sourced from NRIs in 2013, are set to mature between now and December. While the RBI has planned well ahead for this, there’s a niggling worry that the outflow could lead to a spike in demand for dollars, possibly leading to rupee volatility.

What is it?

The Indian rupee had tumbled to its all time low of 68.85 against the dollar in August 2013 as global financial markets were under fire after the US Federal Reserve announced that it would ‘taper’ its QE programme. To bring stability to the wobbly exchange rate, the RBI introduced a swap deal between September 2013 and November 2013 that was meant to encourage banks to attract sizeable dollar inflows in the form of FCNR(B) deposits. FCNR(B) stands for Foreign Currency Non-Resident (Bank) deposits.

Essentially, banks were encouraged to woo their NRI clients to deposit surplus dollars at a fixed interest rate, with the RBI promising to shield banks from the exchange rate risk. On receiving the dollars in 2013, banks were allowed to swap these funds with the RBI for a period of three years while paying a fixed cost of 3.5 per cent per annum. Banks handed over the $26 billion raised from the FCNR deposits to the RBI, to receive the rupee equivalent under the swap arrangement.

So what happened in the deal process? Let us assume that 60 per dollar was the exchange rate fixed for the swap agreement. So the RBI would have given the banks ₹1,56,000 crore (60 * $26 billion) after receiving the $26 billion from them under the swap agreement. Now banks are obliged to swap back the sum raised with the RBI. The central bank will in turn provide the dollars needed for banks to repay their NRI depositors.

Why is it important?

The redemption amount of $26 billion represents a huge outflow of foreign currency. Yes, the RBI has built up a large enough kitty of forex reserves ($367 billion at last count) and also bought forward contracts on the US dollar to repay the banks.

But if the parties who have sold those forward dollars to RBI are unable to pay up, they may have to step into the open market to buy dollars. This may spark volatility in the currency markets in the months ahead. The sudden outflow of capital from India could also tighten domestic market liquidity temporarily.

Why should I care?

If you are an NRI who was lucky enough to have invested in FCNR(B) deposits, you would have made a neat packet not only by way of the interest earned on deposits, but also the dollar strengthening against the rupee in this period.

The rupee has strengthened from around 68 to around 66. But if you have forex obligations coming up, September to December may be choppy. If you are planning a winter vacation abroad or any foreign trips in the next couple of months, you should not be surprised to see a slightly weaker rupee. That would also be negative if you are an importer of goods or commodities. But given that market players have been bracing for this outflow for a long time , any such effect is likely to be temporary. Remember, the news that is already in the markets is already in the price.

The bottomline

There are occasional free lunches in the financial markets. But they don’t last long.

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Published on September 12, 2016
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