The Reserve Bank of India’s (RBI) decision to absorb the foreign exchange hedging cost on fresh foreign currency non-resident (bank), or FCNR (B), deposits is creating an unusual opportunity for overseas Indians: the possibility of earning equity-like returns from what is essentially a fixed-income product, market participants said.
The move, announced on 5 June as part of a broader package to attract dollar inflows and support the Indian rupee, allows banks to raise fresh and renew existing FCNR (B) deposits of three to five years and swap the dollars with the RBI at a concessional rate. Hedging cost for banks will be zero, effectively removing a major cost that previously prevented banks from offering attractive rates on dollar deposits. The scheme is open till 30 September.
What is attracting the attention of private bankers and wealthy NRIs is not merely the higher deposit rate but the ability to offer leverage.
According to calculations by Emkay Global Financial Services, an investor putting in $1 million from his/her pocket and leveraging it nine times could generate annual returns of about $220,000, translating into a return of 21.8% on the original amount invested. Even at lower leverage levels of five times and three times, returns work out to 15% and 11.6%, respectively.
An NRI with $1 million can use that money as collateral and borrow an additional $9 million from an overseas bank. The NRI then places the combined $10 million into an FCNR (B) deposit in India. If the FCNR deposit earns 6.5% while the borrowing cost is around 4.8% linked to secured overnight financing rate (SOFR) plus a spread, the investor pockets the difference on the borrowed money while earning the full deposit rate on the original capital.
SOFR is a benchmark interest rate that reflects the cost at which banks and financial institutions in the US borrow cash overnight by pledging government securities as collateral. Banks add a margin to the SOFR while lending to clients.
FCNR (B) account lets an NRI maintain a fixed deposit in India in foreign currency and the funds in this account and the interest earned are tax-free in India and are freely repatriable with no limits.
Banks expect strong inflows
“In the last round which happened in 2013, most of the money came through the leveraged deposit structures. We expect the same to happen this time as well. The effective returns for the NRI depositors are going to be very good,” said Neeraj Gambhir, executive director at Axis Bank.
Emkay Global Financial Services echoed the view, saying that the FCNR (B) window could see huge inflows as investors take advantage of the ability to take leverage. “This underpins our confidence that flows under the scheme could be at least $50-55 billion or 1.2% of GDP, similar to the levels seen in 2013, and possibly even higher,” the brokerage said.
Federal Bank’s head of liabilities, PV Joy, welcomed the move. “The talk of ‘equity-like’ returns is mathematically real, but it is heavily reliant upon a classic leveraged arbitrage play,” he said, adding that the bank expects a positive response to this move.
“It is a phenomenal, low-risk windfall for ultra-high-net-worth individuals while this special RBI window remains open, but regular (unleveraged) retail NRI depositors should expect their steady, guaranteed 6.25% yield,” he said.
Joy expects a strong double-digit growth to Federal Bank’s FCNR portfolio through the next quarter and believes it will help grow the book by a healthy margin. Of the total ₹3.13 trillion deposits of the bank, NRIs accounted for ₹1.02 trillion for the March quarter.
Banks have moved quickly to pass on the benefit. State Bank of India has raised its FCNR dollar deposit rates by 230-265 basis points to 5.25-6.00% for three-five year maturity. HDFC Bank also increased its rates to 6.00% per annum from 3.40-3.65% earlier for the same tenures.
As of March, the current outstanding FCNR (B) deposits were $33.8 billion, nearly unchanged from a year ago, according to a report by SBI’s Ecowrap on 9 June.
Lessons from 2013
The last time when such a scheme was announced during the taper tantrum in 2013, the banking industry raised around $34 billion from FCNR deposits, and the biggest beneficiary was HDFC Bank raising $3.4 billion, followed by SBI at $3.07 billion and ICICI Bank at $2 billion, Suresh Ganapathy, managing director at Macquarie Capital Securities said in a note to investors on 9 June.
“The reason why these banks dominate is that you need to have a representative office at the least otherwise you can’t offer such leveraged products to your clientele…So that makes easier for them to gain a lion’s share and all the three – HDFC Bank, SBI and ICICI Bank have good international presence,” Ganapathy said.