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RBI Collects $10 Billion from FCNR Window, But Uses it to Sell in Market

The RBI has announced that it has collected a phenomenal $10 billion through the FCNR dollar swap arrangement.

The Reserve Bank has received till date USD 10.1 billion under the special concessional window for swapping Foreign Currency Non-Resident (Banks) Deposits and Overseas Foreign Currency Borrowings. The Reserve Bank of India had announced these schemes on September 4, 2013.

The FCNR swap is open till November 30,2013.

Has this helped our forex reserves? Obviously it should, since forex reserves will be augmented. Banks sell the dollars to the RBI for rupees (at 3.5% p.a.) and the dollars sit on the RBI balance sheet until the swap is unwound (a minimum of three years).

RBI Forex Reserves

Source: RBI

As you can see the dollar reserves have gone up since 5 Sep (when the FCNR announcement was made)

Has this helped the dollar? Or course it seems to have.

USDINR since July 2013

This doesn’t make a heck of a lot of sense – how can the dollar exchange rate be impacted when the dollars coming in are being bought directly by the RBI? The dollars that are being sold should somehow hit a market – where there will be more selling pressure than buying pressure, which thus brings the price down.  (Currently the swap works on the RBI reference rate, which is a once-a-day poll by the RBI and is fixed for the day)

You can also see above that the reserves have increased only by $4 billion, from $247 to $251 billion. But they got $10 billion through the FCNR route  – in fact they already had $5bn on Oct 4, as per Rajan. That means the RBI must have sold the remaining dollars in the market.

The dollar rate has fallen, and that’s a good thing. However, it’s not because of the FCNR borrowing. It has just helped the RBI keep the reserve steady while they sold like crazy in the real market to protect the rupee – at least, that’s what it seems from the above data. RBI has also sold dollars directly to OMCs through another swap, which confuses the whole issue somewhat.

I hope there will be more data about all of these going forward – how much do we have to return in the FCNR swaps, how much through the OMC swaps, and when, etc.

The Downsides: You’re going to live at least three years longer, you think? Then three years later, it’s time to return this money, and we better hope we have our act together by then. Because then – and this is Sep-Nov 2016 – we will have to remove Rs. 50,000 cr. from the system, which can contract liquidity. But importantly, that many dollars go out of RBI reserves – and therefore sets up a schedule for yet another weak point for the currency.

We must absolutely make the Indian rupee freely convertible by then.

The other downside is inflation. $10 billion is 60,000 crores of rupees added to the system, minus whatever RBI has bought by selling dollars directly. Even if that’s $4 billion, that much more money is coming into the system today. Inflation is already high, and this new “reserve” money will hit the system within a few months and cause serious inflation.

  • Leo says:

    GOOD analysis … really well done i had similar things in my mind.COngrats for the good work

  • Uma says:

    What will be the impact of the capital infusion in PSU Banks? Will it lead to further fall in Rupee?

  • Rudra Chowdhury says:

    Great work Deepak, would also like to know your views on the alternatives which could have been deployed here, the depleting forex reserve were a serious threat on import cover and unless the RBI had another source of easy dollars it couldn’t have just went ahead and sold like it did here.
    Also as Samir Arora pointed out this dollar collection was always an option on the cards, but where there is desperate need to do it now is the moot question. your views please.

    • Rudra, I don’t believe an import cover is necessary; and btw, this doesn’t provide any layer of import cover because this is a liability that can’t be covered anyhow. We have import cover through the $50 bn swap with Japan, which isa far better way to do things.
      A much better alternative would have been to open up the rupee, completely removed restrictions on hedging limits and trading limits in the forex market and of allowing foreigners to hold much more debt than tehy can (and without sectoral limits). That’s true reform, and done with our backs to thewall, would have gotten rich results in about the same time, and then it doesn’t have to be unwound!
      For imports, we can – and should – work with our partners to pay in rupees. As a deficit country we have the necessary quantity to satisfy many of our large partner’s needs (indonesia for example).

  • Rajat Bose says:

    Very good post. Keep it up, it’s really a pleasure reading your posts.
    I have one issue here. While replying to Rudra, you have made a case for “true reform”–I take it that you want serious economic reforms in this respect or in other fields would have benefited us in getting better capital flows. This seems to in line with the dominant paradigm, which advocates that if you undertake economic reforms you are likely to attract good quantum of capital inflows. This thesis, however intellectually appealing, does not stand historical scrutiny.
    There had been cases of countries like Chile or Columbia exhibiting much greater orthodoxy in implementing free market policies ( much more than even the United States) in the latter half of the last century yet failing to attract capital inflows while they also received a lot of capital later towards the close of the last century when other countries in the region like Mexico attracted similar such inflows. This much talked about correlation between economic reforms and capital inflows does not hold even when you go further back in history either.
    Capital flows are dependent more on exogenous variables like gush of liquidity in the world monetary system rather than reforms if economic history is anything to go by, notwithstanding the fact that in this specific case the FCNR window did bring in USD 10 billion. The tapering off of the bond purchases by the US FED, whenever that happens you will see the drama being reenacted again may be on a larger scale. If we manage to scale down our external debt by then, may be we would have a lesser impact else the scenario could be quite dicey. Unless an emerging market economy, which has received a lot of such capital (mostly in some form of debt) inflows in boom times driven by liquidity, corrects its capital structure imbalances it is bound to suffer–at least, that is what historical patterns tend to suggest.

    • Thanks Rajat!
      I think I’ll differentiate between serious economic reform in general and the impact on bringing in financial flows. In this particular case, we don’t allow financial flows easily and we should rectify it – the reform is in the area of financial flows itself. Easing flows and making the rupee convertible can help in one major factor – trading using rupees. That should be a goal – we are one of the few developing nations that has a decent sized current account deficit – China, Brazil and Russia have been in surplus modes. That by itself won’t ensure financial flows, but here’s the thing – it will reduce the need for dollar inflows – if you can pay with rupees, then you don’t need that many dollars.
      But good policy in general needn’t attract flows. like if we have labour reform, we are first likely to see flows EXIT the country. If we catch all the scamsters, we will find a lot of FIIs will leave (because they are fuelled by black money). If we ease up on the capital account too, we will see dollars leave and only return when we start to perform. But without one such cycle we won’t get anywhere – or, we’ll get somewhere where there is another larger crisis waiting.
      Agreed that we will correct nonetheless, as liquidity patterns change. However to be ready for that will need us to be competitive and perhaps to get strength the economy will need a shakeup before it turns back.

  • Kannan S says:

    Great work Deepak.
    Regarding inflation that is going to come to the system, can you please elaborate on the money multiplier effect of this 60,000 crores of rupees injection? Thanks.
    Sriram Kannan