Oct 04, 2013 10:33 AM IST | Source:

The FCNR dollar fest: No free lunch here

On September 4, the new RBI governor Raghuram Rajan announced that foreign banks can swap (exchange) this money for rupees for 1-3 year periods at 3.5 percentage points lower than the market rate.

Don't be deterred by this ugly abbreviation – FCNR. It simply means foreign currency non resident. It's a savings account offered by banks to Indians living abroad and who deposit money in dollars. In this account, the depositor gets back the money as dollars. There are some accounts where the dollars is converted into rupees and it gets a rupee interest rate, like in any Indian bank. That's NRERA. But we can ignore this for now. In the FCNR account the rates given are comparable to what a non-resident Indian gets in any country. It moves with the US Fed rate or the LIBOR and the India country risk. Indian banks pay 4 percent over LIBOR for FCNR dollars.

Also read: PSU banks to get more funds to lend to auto, cons durables

On September 4, the new RBI governor Raghuram Rajan announced that foreign banks can swap (exchange) this money for rupees for 1-3 year periods at 3.5 percentage points lower than the market rate. After the 3 year period, RBI will give back the money in dollars, whatever the cost of the dollar. For a similar arrangement in the market, i.e. to swap money into rupees and get back dollars after 3 years, one would be charged LIBOR plus 7 percent. RBI doing the same for LIBOR plus 3.5 percent is a steal for the banks. But idea was to attract more dollars into the country, so that the attack on the rupee stops.

I may add, the product is extremely successful, for the NRI and more so for the foreign banks. For an NRI, who puts in USD 100, the foreign branch of the bank normally gives a loan of 9 times i.e. USD 900 at 3 percent. The NRI puts the entire lot in the Indian branch of the same bank to get LIBOR plus 4 percent on USD 100, i.e. he gets USD 40. Subtracting the USD 27 he paid the bank for the loan, he still makes USD 13 on 100, i.e.13 percent. And the bank swaps the money with RBI at 3.5 percent below market rates. It makes that 350 basis points and it hasn't to maintain SLR or CRR on that money which is a further saving of around 1 percent. Ask any banker, making 4.5 percent risk free over and above your normal margins is delicious butter, jam and cream for foreign banks.

My reason for saying all this is that the stability of the rupee is not coming for free. The nation is allowing foreign banks to make huge profits. Yes, the dollar has cheapened and there is stability. Giving that 3.5 percent lower than market rate was RBI's way of saying that that's where the swap rate should be. But let us look at the counterfactual. The Indonesian rupiah, Brazilian real, Turkish Lira and South African Rand were all decimated in August and all of them recovered in September as the Fed said “no tapering”. And as the Syrian crisis subsided some what. We are probably giving more credit to the FCNR product than needed.

I would rather we  withdraw this product at the earliest and set in motion policy and economic changes that crunch the current account deficit. Historically we have repeatedly lived beyond our means and solved the problem by giving huge sops to foreigners. Post the BoP crisis of 1991, we opened the doors to FIIs. But we had to give them sops. We gave FIIs the Mauritius route. They can make money on our high interest rates, on our equities and they don't have to pay any tax, under the umbrella of the double tax avoidance treaty with Mauritius.  Likewise the witholding tax that investors pay globally on the interest they earn in foreign countries has been cut out  for those investing in India. And now we are allowing foreign banks to make money hand over fist because we need dollars. Of course all banks can offer this product to their NRI customers, but let's face it. Indians living aborad and working with multinational companies are more likely to have salary accounts with foreign banks and hence it is the HSBCs and Citis and Stancharts who can more quickly tap the NRI customer and who are hence making this risk free 4.5 percent over and above their normal margins..

The lessons we need to learn is  when we are in distress the money lender, whoever he is – IMF, FII or  foreign bank will charge the earth and our governments have to cough up by paying from the tax kitty or foregoing taxes. A second lesson is that due to the success of the scheme, the government has lost the pressure to reform. We were all expecting a stiff diesel price hike. But with the rupee pressure off, the government is inclined not to reform.

That brings me to the third point.  Rupee depreciation is a better way to correct the current account deficit than unnatural schemes like giving tax cuts to FIIs and generous rates to foreign banks. Yes, again, I accept there was a need to stop the run on the rupee, which was creating more macro problems. But a slower depreciation of the rupee is better way to strengthen the country's exports, lower competitive imports and give a boost to Indian industry all round. The enforced appreciation of the rupee cuts this boost to industry. Hence it is important that the RBI withdraw the incentives to FCNR accounts sooner rather than later.

Follow us on
Available On