FCNR(B) flows pour into 5-year G-secs under RBI's concessional swap window

Foreign lenders with relatively small loan books emerge most active buyers; bond yields soften

The five-year government bond has emerged as an outperformer since June as commercial banks, particularly foreign lenders, deploy the liquidity generated by the mobilisation of foreign currency non-resident (bank), or FCNR(B), deposits under the Reserve Bank of India’s (RBI’s) concessional swap window.

 

Foreign banks, which do not have the same scale of retail and corporate lending books as domestic lenders to absorb the inflows at the pace they are arriving, have been among the most active buyers of three- to five-year government securities, pushing yields lower at the shorter end of the curve.

 

The five-year bond yield has fallen more sharply than the 10-year benchmark since June 1, widening the spread between the two from 19 basis points to as much as 46 basis points last week. The spread stood at 41 basis points on Monday. Similarly, the spread between the benchmark yield and the 3-year bond yield widened to 57 basis points on Monday, against 45 basis point on June 1.

 

The move reflects both the surge in banking-system liquidity and banks’ preference to deploy it in shorter-duration assets rather than take on significant duration risk. 

 

“The increase in short-term bond demand has been reflected in the yield curve, with the five-year segment seeing a sharper decline than the 10-year benchmark. The 10-year yield has remained comparatively stable as banks have preferred to limit duration risk while deploying the additional rupee liquidity,” said a dealer at a primary dealership.

 

Foreign banks had mobilised more than $8 billion of FCNR(B) deposits by the end of July, with HSBC alone accounting for more than $6 billion. Market participants said these lenders were directing a substantial portion of the funds towards government bonds because their retail and corporate loan books were not large enough — vis à vis domestic banks — to absorb the liquidity. 

 

“Foreign banks don’t really have avenues to deploy this money in loans at the pace it’s coming in, so a large part of it is going into short-term bonds. That’s what softening yields at the shorter end,” said the treasury head at a state-owned bank.

 

Dealers expect the spread between the five- and 10-year bonds to widen further by September as banks continue to deploy the inflows ahead of the September 30 deadline for mobilisation under the FCNR(B) scheme.

 

The RBI’s US dollar-rupee forex swap facility is available for fresh FCNR(B) deposits mobilised for a minimum tenor of three years and a maximum of five years. The facility is available until September 30.

 

The other factor supporting the five-year segment is the surplus liquidity in the banking system. During time of surplus liquidity, dealers said, banks typically deploy funds at the shorter end of government bond curve. Surplus liquidity, measured by funds parked with the RBI’s liquidity adjustment facility, has remained above ₹3 trillion in recent days.

 

Private and state-owned banks are using much of this liquidity to replace costly bulk deposits raised earlier at higher rates, dealers said. The has also fed through to the certificate of deposit market, where rates have declined as banks have become less reliant on bulk and CD funding to meet their liquidity requirements.

 

A smaller portion of the excess liquidity at these banks is also being deployed in three- to five-year government securities as lenders assess the pace of credit demand before committing to longer-duration assets.

 

“The immediate deployment is likely to remain concentrated in the three- to five-year segment, as banks may not want to take duration risk with the liquidity, particularly when they are still assessing the pace of credit demand,” the treasury head said.

 

C S Setty, chairman of State Bank of India, said at a post-earnings press conference that he expects the liquidity generated through FCNR(B) flows to ease pressure on bulk deposit pricing across the banking system. Lenders, including SBI, are likely to avoid aggressively pricing bulk deposits as long as these inflows are sufficient to cover credit growth, he said.

 

Setty also noted that FCNR(B) mobilisation has not been uniform across banks, meaning larger lenders able to attract such deposits would see greater relief in their bulk deposit rates.

 

Total inflows under the facilities stood at $40.82 billion as of July 31, up from $20.72 billion on July 17, according to central bank data. FCNR(B) deposits accounted for $36.73 billion, while overseas foreign currency borrowings contributed $2.58 billion and external commercial borrowings $1.52 billion.

 

SBI Research has raised its estimate for FCNR(B) inflows over the full window to $65 billion-$70 billion from its earlier projection of $40 billion-$45 billion. Including overseas foreign currency borrowings and external commercial borrowings, total inflows could reach $80 billion-$85 billion, it estimated.