The RBI’s special FCNR(B) deposit and swap window attracted much stronger inflows than expected.
Economists say the surge could raise liquidity-management and hedging costs, although investment returns may offset part of the burden.
Highlights:
- RBI’s special diaspora deposit programme attracted significantly higher-than-expected dollar inflows.
- Economists estimate the central bank could face a potential cost of around $10.6 billion.
- FCNR(B) swap protection is estimated to cost the RBI about 3% to 3.5% annually.
Record Dollar Inflows Create ‘Problem of Plenty’ for RBI
India’s record fundraising from its overseas diaspora has strengthened foreign exchange inflows but could also leave the Reserve Bank of India with a sizeable financial cost, according to economists.
The central bank’s special deposit programme attracted far more money than originally expected. The final amount could rise further after foreign-currency debt raised overseas and external commercial borrowings are taken into account.
The programme was introduced in June as part of efforts to support the rupee after the Indian currency fell to record lows. Strong dollar inflows helped improve foreign exchange availability, but they have also created new challenges for the RBI in managing banking-system liquidity.
Under the Foreign Currency Non-Resident (Bank), or FCNR(B), programme, the RBI offered banks a favourable currency-swap facility. This protects banks against losses if the rupee weakens against the dollar.
Economists estimate that the swap facility could cost the central bank around 3% to 3.5% annually. The RBI may also have to absorb excess rupee liquidity created when banks convert the dollars raised overseas into domestic currency.
According to an analysis by Emkay Global Financial Services economist Madhavi Arora, the combined cost of these operations could reach as much as ₹1.2 trillion, or about $12.7 billion, over five years.
The potential burden has also raised questions about its impact on the RBI’s surplus transfer to the central government. The central bank transferred a record ₹2.87 trillion to the government in May, compared with ₹2.69 trillion a year earlier.
A lower dividend in future could make it more difficult for the government to meet its fiscal and budget targets.
However, the overall impact may be considerably smaller if the RBI earns strong returns by investing the dollars abroad.
For instance, investments in 10-year US Treasury securities yielding around 4.7% could generate enough income to offset a large part of the hedging cost.
IDFC First Bank economist Gaura Sengupta estimated that the RBI’s net annual cost could fall to around ₹10,000 crore and could even turn marginally positive depending on investment returns.
Repayment of the deposits is also not expected to pose a major challenge, given India’s foreign exchange reserves of around $730 billion and expectations that the reserves will rise further over the coming years.
