FCNR (B) Scheme, 2013 [4]

In September 2013, RBI surprised the market with a "non-conventional" measure. It decided to offer special swap rate against FCNR deposits.

This article dives into one of the biggest rescue plan for Rupee, drafted under former RBI governor of Mr. Raghuram Rajan.

The plan was based on the idea to offer a cheap forward rate of just 3.5% p.a for banks so that they raise a “sizeable amount” of foreign deposits and hedge their risk at an attractive rate.

RBI Notifications

:rbi:RBI Notification - Swap Window for Attracting FCNR (B) Dollar Funds
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=29480
https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8388&Mode=0

Higher price of dollar hurts India as India is a net importer. It also creates panic among foreign investors and leads to “further” outflows/buying back of dollars. Hence, RBI was under pressure to raise/sell some serious amount of foreign exchange in August 2013 to prevent further “volatility” in value of USD.

Under the leadership of Raghuram Rajan, RBI suggested raising $ from abroad with use of FCNR (B) deposits.

:question: What is FCNR (B) Deposit?

It is a deposit scheme for NRIs or a Person of India origin, who can deposit their foreign currency with an Indian Bank in form of FCNR(B) deposits

  • Deposits can be opened in USD/GBP/JPYAUD/CAD with a term of 1-5 years

  • Depositors receive back principal and interest in original currency on maturity

  • Maximum interest rates between LIBOR/SWAP +2OO bps (1 to <3 years) to LIBOR/SWAP +400 bps (>3 to 5 years). This ceiling rate is decided by RBI and rates are published are by FEDAI

  • In October 2013, FCNR (B) deposit rates were between 4.78-5.53 % on (>3 to 5 years) vs local borrowing rate or prime rate of 3.25%

:rbi: Master Circular of instructions relating to deposits held in FCNR(B) Accounts
https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=8120

Advantages of FCNR (B) Deposits

  • Low rates on Certificate of Deposits (0.25-0.5%) compared to FCNR (B) deposits
  • NRIs could even borrow locally at interest rate 3.5-4% and offer it to Indian banks as FCNR (B) deposits for >5%
  • Positive sentiment towards India
  • No currency risks
  • NRIs can even avail of loans against FCNR(B) deposits
  • Both Principal and interests are not taxed and are fully repatriable

:thinking: How did the Swap work?

:spiral_calendar: At the start of the year

  • On 23rd Sept. 2013, Spot Rate = Rs 62.63
  • First Leg - Banks sold $1 to RBI at Rs 62.63

:spiral_calendar: At the end of year

  • Assuming, banks invested at rate of 10%, they had Rs 68.89 at the end of one year

  • Second Leg - Banks bought back $1 from RBI at rate of only 3.5% p.a., which was Rs 64.84. This is the one year forward rate/swap rate by RBI

  • So, banks had \frac{68.89}{64.84} = 1.06246 in their hand for $1 raised

  • Thus, they made 6.25% returns (before their transaction costs)

How much banks had to return?

FCNR(B) rates were 3-4% to NRIs vs assumed 6.25% returns made by banks due to cheaper forward rate/swap rate

:rbi: FAQs on Swap Window for attracting FCNR (B) Dollar funds
https://m.rbi.org.in/Scripts/FAQView.aspx?Id=98

:hammer: Impact of Special Swap Window for FCNR(B) Deposits

  • The scheme was win-win situation for banks & NRIs

  • Within few days, banks raised up to $30 billion due to promise by RBI of giving them back dollars raised (as it was swap transaction) at cheaper rate.

  • RBI now had $30 billion to sell in open market and control the sharp in value of INR vs USD. The best part was RBI could sell dollars without digging much into its own reserves.

  • Importers like Oil Marketing Companies, also called OMCs, rejoiced as value of USD vs INR went down. Unhedged Exporters lost value of receivables as value of dollar versus rupee fell.