Foreign Exchange Markets May Turn More Volatile
This is basically because the demand and supply of foreign currency will increase dramatically.
In the detailed circular issued yesterday, by the Reserve Bank of India (RBI) it was stated, "as the credit risk on account of foreign currency loans is significantly greater than is the case with rupee loans, particularly in respect of borrowers who do not have a natural hedge, banks will have to be extremely vigilant in sanctioning and monitoring these loans."
That apart, the circular has also stated that banks should ensure that mismatches do not arise on account of such lendings.
However, under exceptional circumstances, mismatches may occur.
Managements in banks may therefore fix limits for such mismatches.
Both these guidelines will lead to an increased volatility in the exchange markets. First, the Reserve Bank of India has permitted banks to give foreign currency loans to corporates who do not have foreign currency earnings.
Most of these corporates will borrow these funds to meet their import requirements and hence at the time of repayment, they will have to enter the exchange market and buy the dollars to repay.
This will essentially put pressure on the spot market. It is felt that corporates will not go for forward cover as then the benefit of borrowing in foreign currency is nullified.
If one adds the forward cover cost to the interest, the total cost of funds will work out more than 14 per cent. Even if the corporates tend to go in for forward cover there will be a pressure on forwards.
The second fact that will put pressure on the exchange market is the fact that banks are allowed to have mismatches. This means has major implications.
Say for instance, a bank has a FCNR (B) deposit maturing in three months it is allowed to give a loan for six months.
This means that when the FCNR (B) deposit matures, the bank will have to enter the market to buy the foreign exchange to repay.
The banks will also be exposed to an interest rate risk.
However, the Reserve Bank of India has taken care that mismatches do not spin out of control by asking banks to fix the limits.
A copy of the board sanction note, approving these limits, will need be submitted to the Reseve Bank.