It resembles a movie script, the Rupee has been destabilized by unidentified forces, it has started to roll down the slope, slowly, the speed of the fall is accelerating and it is rushing towards a chasm. People are horrified and desperately try to arrest the slide by throwing obstacles in its path, the ‘fall of the Rupee’ however shows no sign of abating; It is a tense situation.
Desperate times need desperate measures and times such as these needed some really sound measures, else the Rupee could disappear into the chasm. “When the going gets tough, the tough get going” and Dr. Raghuram Rajan, the new RBI governor, proved to be tough and equal to the task. He introduced a slew of measures to tackle the situation. The slide had to be stopped and then the Rupee needed to be pulled back to a respectable position.
The swap window introduced by the RBI for attracting FCNR (B) funds is one such step towards stabilization of the INR. A quick look into the concept of FCNR (B) (Foreign Exchange Non Resident (Banks)) funds tell us that this scheme is meant for Non Resident Indians (NRIs’) or Persons of Indian Origin (PIO’s) depending on their Residential Status.
Interest earned by investing surplus funds in the respective (select) adopted country’s currency by NRIs’ usually yields a much lower return when compared to the returns earned if invested in India. However, investing in India can be risky if the fund is not protected against Foreign Exchange rate fluctuations.
FCNR (B) fund is the ideal investment option for NRIs’ and PIOs’ as it eliminates the foreign exchange risk and allows them to hold Fixed Deposits in their respective currencies (US Dollar, British Pound, Euro, Japanese Yen, Australian Dollar, Canadian Dollar) and earn interest on them. The principal and interest on FCNR (B) deposits are fully repatritable and is not taxable in India. Loans upto Rs. 1 crore are allowed on FCNR (B) deposits with reference to their base rate and repayment can be made in either INR or foreign currency. Banks allow FCNR (B) deposits up to a maximum tenure of five years.
Here are a few salient points relating to the interest payment, interest rates and relevant rules and regulation which governs FCNR (B) deposits.
Payment of Interest
FEDAI (Foreign Exchange Dealers Association of India) publishes the LIBOR/Swap rates on a monthly basis for FCNR (B) deposits on their website (fedai.org.in).
Usually banks are apprehensive about converting foreign currency into INR as they are exposed to the risk of currency depreciation. The 3.5% fixed rate allows the banks to lock their total cost of deposits
and leave them free to invest the fund in INR assets at a higher rate.
Let us take an example to illustrate the mechanism. A bank paying a return of 5.7% on a five year USD FCNR (B) deposit can approach the RBI and swap the USD to INR at a fixed rate of 3.5%. Thus the total cost to the bank is pegged at 9.27% (5.77%+3.5%). As per the current scenario, a five year AAA rated corporate bond is going to fetch a return of 10%. This will leave the bank with a margin of profit. The banks are also at liberty to lend the money to lower rated borrowers at a substantially higher level of yield.
USD interest rates are extremely low, at around 2%, and the FCNR (B) is an attractive option for the investor to park their funds without the risk of currency fluctuations. With the swap window in place, banks can go forward and aggressively market the USD FCNR (B) deposits to NRIs’. Banks can also earn an arbitrage between USD and INR interest rates.
These 3 factors make this FCNR (B) deposits more attractive for NRIs. The 3 year lock in period is something which they need to think through.
FCNR (B) Deposits are really a win-win situation for NRIs, Banks, and RBI. NRIs get more returns without currency risk. Banks generate more deposits and income. RBI gets more Dollar inflow.
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