Banks unlikely to rush to raise foreign currency deposits

Market's expectations of $15 billion appears stretched, as incentives may not bring down cost of funds substantially

The RBI has incentivized domestic banks to raise foreign currency non-resident deposits, in its bid to shore up its depleting foreign currency reserves. Several economists expect close to $15 billion coming in through this route.

By offering incentives on the hedging costs, the RBI has helped bring down the cost of funds for banks to opt for this route even though it has allowed banks to offer higher interest rates on these deposits. However, analysts say it isn’t attractive enough.

So what has the central bank done? For starters, RBI has allowed banks to offer rates which are 400 basis points higher than Libor. Earlier, the RBI had capped this rate at 300 basis points higher than Libor.

Banks raising such deposits overseas have also been given exemptions on SLR, CRR and priority sector lending requirements.

Besides, banks that raise such deposits for three years or more can hedge these incremental deposits at a fixed rate of 3.5% per annum at a special RBI window. This would halve hedgng costs for banks. Additionally, banks can raise deposits up to 100% of their Tier 1 capital compared to the earlier 50% cap.

No doubt, India needs every dollar it can garner, but analysts say banks are not dying to do this. While the incentives may bring down cost of funds by funds by 125-200 basis points compared to the prevailing domestic rates, banks are unlikely to rush to raise these deposits. Analysts say that currently such deposits are at merely 15% of Tier 1 capital of banks.

Ambit Capital says that despite a discount of 100 bps on the swap facility, the cost of such funds is higher than the marginal borrowing costs of banks in domestic market. Overall, the brokerage does not expect cost of fund of Indian banks to come down significantly due to the recent measures taken by the RBI to make foreign currency borrowings and deposits attractive for Indian banks.

Analysts say that if $15 billion does come in through this route the pressure on the currency would ease, but it is highly unlikely as the total outstanding FCNR (B) deposits at the end of FY13 were at $15 billion so another $15 billion through this route seems highly implausible. If this does happen, then it would be the highest NRI deposits raised by Indian banks in any single year.

Bank of America Merrill Lynch’s economist Indranil Sen Gupta says, “Recent events do vindicate our call that the path to rupee stability lies through NRI deposits rather than rate hikes. Yet, we estimate that the recent measures will add a bare $5 billion to forex reserves in FY14 when the import cover has halved to seven months - last seen in 1998!”