Going by early data, as reported, the Reserve Bank of India (RBI) may have got its aim right on target. So far, more than $17 billion has been raised by banks as foreign currency non-resident (FCNR) deposits since RBI rolled out an incentive scheme last month to attract dollars into its forex cushion.
As more overseas Indians work out the details of what’s on offer and arrange funds to deposit, inflows could rise before this window closes (end September, that is).
Under RBI’s swap facility, it acquires those dollars at today’s exchange rate only to return the money to banks at the same rate as and when FCNR deposits mature (in 3-5 years).
Relieved of the risk of a heavy payback burden should the rupee slide over that time-span, Indian banks need no currency hedge and can thus afford to offer globally high rates of interest to lure forex.
The dazzle of this investment proposition for big-ticket investors, though, lies in the leverage packages crafted by various banks that spell high potential for double-digit annual returns.
So what exactly has been rolled out as a red carpet for the dollars of overseas Indians?
Not only does RBI bear the currency risk, Indian tax has been waived on the interest earned by these depositors. This basic bounty is enlarged significantly by cheap bank loans on offer against an initial deposit acting as captive collateral.
In effect, an investor with $1 million at hand can earn the annual rack rate of 6.5%, say, on this lumpsum—plus the gap in rates between cheap loans and 6.5% on say another $9 million deposited. All it takes is some paperwork to put leverage at the service of interest rate arbitrage.
The math makes the outcome look dramatic: a leveraged dollar depositor could earn returns well above 10% per year—as calculations show, even in the mid to high teens—although a rise in floating rates on such borrowings over the next 3-5 years could act as a squeeze.
Since the target audience can be expected to trust the financial commitments of RBI-regulated banks, the FCNR yield premium over safe-haven assets like US Treasury bonds has put this special window under the arclights from Singapore to Dubai and beyond.
As a scheme, it’s just a stop-gap for a forex crunch, the cost of which RBI will have to reckon with once repayments come due. It does not relieve India of the need to boost its trade earnings and capital inflows, the anxiety that led to this effort. Given our war-afflicted external balances, domestic savers would not begrudge it.
Yet, such savers should be pardoned a twinge or two of envy. Rupee fixed deposits with local banks typically yield no higher than 6.5% annually, with tax on interest levied by one’s income slab. This, even as an uptick in inflation seems set to threaten real returns (if RBI’s policy rate does not keep pace).
As it is, for many years, a squeeze of real returns on low-risk savings has been the wind behind a flight of bank deposits into equities. Sure, India’s stock market has had its own appeal at the retail level.
Even so, as its performance of late has been a public lesson in sobriety, savers driven into a relatively risky returns chase—recall the post-covid boom in demat accounts—by low deposit rates might yearn for the comfort of fixed income options.
At the other end, with few lucrative avenues in sight, foreign stocks beckon. At scale, this could turn into a flight risk, capped only by capital controls. All said, while FCNR inflows are good news, let’s spare a thought for resident savers too.