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RBI Cuts EEFC Balances to 50%

RBI allows exporters to hold their forex earnings in an Exchange Earners Foreign Currency (EEFC) account. This is so that they can pay in forex for stuff they want to buy, and save on the round trip transaction costs (of conversion to rupees and then back to dollars).

To stem the rupee downslide, RBI has mandated that half of such balances will be converted to rupees immediately. Further, only 50% of future earnings can be used in the EEFC account, the rest needs to be converted to rupees. And then:

The facility of EEFC scheme is intended to enable exchange earners to save on conversion/transaction costs while undertaking forex transactions in future. This facility is not intended to enable exchange earners to maintain assets in  foreign currency, as India is still not fully convertible on Capital Account.  Accordingly, EEFC account holders henceforth will be permitted to access the forex market for purchasing foreign exchange only after utilising fully the available balances in the EEFC accounts.  ADs may, accordingly, obtain a declaration while selling foreign exchange to their constituents.

What this means is that if you’re an exporter and have (after the 50% conversion to rupee) $1000 in your EEFC account, then you can’t buy dollars from the forex market (through your bank) until you first use the $1000 in your account.

It seems exporters were keeping balances in dollars to benefit from the slide in the rupee, a speculatory measure that isn’t quite within the spirit of the RBI rules. Also, it’s a non-level playing field for non-exporters – it’s best that all speculation come into the primary market. I would argue that we should just make the rupee fully convertible instead, and allow ANYONE to hold dollar accounts, but there is absolutely no will for that (they’ll argue that now isn’t the time, I’ll argue it will get much worse anyway).

The other downside? Transaction costs for exporters. A company that buys foreign raw material and exports the finished goods abroad, say crude refiners, will end up paying a large amount for their input and getting dollars for their output. Now, if their margins are less than 50% (that is, what they pay for crude abroad is more than half what they earn from exporting refined product) they will not be able to use their EEFC accounts to offset the payments/receipts. If they need to pay $80 and receive $100, half of the $100 is converted to rupees, so only $50 is available in the EEFC account – they must buy the remaining $30 in the forex market. This has a conversion fee and a transaction cost in both directions.

But in reality, larger exporters set up accounts in their subsidiaries abroad, to make up for their external liabilities. You can’t expect that the money from every Land Rover sale in the UK comes back to a Tata Motors account in India, from where they pay the salaries of their UK staff, the metals etc. Tata Motors will have a UK account where it gets the funds and pays out. Infosys and TCS and most large IT vendors have their transactional accounts abroad. So the EEFC is really a vestige of an older era, and probably misused for speculation instead of what it was intended for.

The last time the RBI did a 50% EEFC cut was in 2000 when the rupee depreciated to Rs. 46 to the dollar. This has shown short term gains with the rupee dropping from near 54 to below 53 on the announcement. But as you might have guessed, this is just duct tape. A few billion dollars in the EEFC accounts will only result in a few days of relief, and then we’ll have to make all those dollar payments and boom, we’re down again. No, sir. This trade deficit is structural, and unless you find a way to reverse it, you’ll see the rupee sliding.