RBI policy: Hike in FCNR(B) deposit rate may have limited impact on flows

The Reserve Bank of India’s (RBI’s) decision to raise the interest rate ceilings on foreign currency non-resident bank [FCNR(B)] deposits is expected to have a limited impact on attracting inflows.

 

This comes as the softening of rates in global markets has led to domestic banks raising funds from overseas investors at highly competitive rates.

 

As a result, industry experts believe that banks are more likely to opt for sourcing funds from global capital markets rather than locking at higher interest rates for NRI deposits.

 

On Friday, the RBI announced that to attract more capital inflows, banks have been permitted, with effect from December 6, to raise fresh FCNR(B) deposits of 1 year to less than 3 years’ maturity. This is at rates not exceeding the alternative reference rate (ARR) plus 400 basis points (bps) and deposits with maturity between 3 and 5 years at rates not exceeding ARR plus 500 bps. This relaxation by the RBI is available till March 31, 2025.

 

Currently, interest rates on FCNR(B) deposits are subject to ceilings of overnight ARR for the respective currency/swap, plus 250 bps for deposits of 1 year to less than 3 years’ maturity. It is overnight ARR plus 350 bps for deposits of 3 years and above and up to 5 years’ maturity.

 

An FCNR(B) account lets customers maintain a fixed deposit in India in freely convertible foreign currencies for a tenure ranging from one to five years.

 

Since the account is maintained in foreign currency, it secures funds against currency fluctuations during tenure of the deposit.

 

According to a senior public sector banker, this move by RBI is unlikely to work as banks already are less active in garnering FCNR(B) deposits at the present interest rate ceiling. Banks will easily get money in foreign currency at rates cheaper than interest rate FCNR(B) deposits, he said.

 

Echoing his views, Gopal Tripathi, head, treasury & capital markets, Jana Small Finance Bank, said, “With the overnight interest rates in both the US and India having narrowed, banks have difficulty to source funds through this channel.”

 

However, he added that while the interest rate differential between India and the US remains low, this move by the RBI is aimed at providing banks an additional avenue for raising funds, thereby encouraging more dollar inflows. These inflows will also likely give a cushion to the rupee.

 

According to latest RBI data, during April-September 2024, about $5.34 billion flowed into FCNR(B) accounts, compared to $1.92 billion in the corresponding period a year ago. The outstanding amount in FCNR(B) accounts stood at $31.08 billion.

 

The decision to raise the upper limit of FCNR rates will not bring any new capital inflows, said SBI Economic Research in a note. It added that instead a cash reserve ratio (CRR) cut on such products would have been helpful.

 

According to three senior public sector bank executives, the easing of interest rate ceiling for FCNR(B) deposits will have minimal impact. This comes as interest rates offered on such deposits are well within the existing ceiling.

 

Additionally, they said, banks would be hesitant to lock themselves in higher rate obligations for longer periods when rates in the global markets are softening. This makes it cheaper to raise hard currency money from the market than take FCNR(B) deposits.

 

“Though the increase in ceiling on FCNR(B) deposit interest rates will have sentimental impact, an actual incremental influx of dollars needs to be watched. This comes as banks’ present dollar FCNR rates are way below the present ceilings available. Hitting the revised upward ceiling will increase the covered cost of funds through the FCNR route significantly adding to the impact due to the recent surge in forward premium induced by the large rupee volatility,” said Mandar Pitale, head of treasury, SBM Bank India. 

Status check

  > During April-Sep, $5.34 bn flowed into FCNR(B) accounts

> The outstanding amount stood at $31.08 billion

> FCNR(B) account helps maintain a fixed deposit in India in freely convertible foreign currencies for a tenure ranging from one to five years