Targeted flows, not swap cost, drove early FCNR (B) closure: SBI Research

The cost of FCNR (B) swaps is unlikely to have been a constraining factor for the Reserve Bank of India's (RBI) decision to close the special swap facility ahead of schedule, according to a report.

SBI Research, in its report Ecowrap, estimated that the cumulative hedging cost could amount to around USD 10.5 billion over five years.

On August 14, the central bank decided to close the window for fresh FCNR(B) deposits under the special swap facility on August 31, one month ahead of the scheduled September 30 closure.

SBI Research said the potential FCNR(B) mobilisation of USD 65-70 billion, combined with an average USD/INR hedging cost of around 3 per cent per annum, implies an annual notional hedging cost of about USD 2.1 billion on a USD 70 billion corpus.

 

If this cost were to remain at 3 per cent over the five-year maturity of the deposits, the cumulative cost would amount to around 15 per cent of the corpus, or USD 10.5 billion, the report said.

With current reserves at around USD 700 billion and incremental reserve accumulation assumed at roughly USD 20 billion annually, the five-year cumulative hedging cost of USD 10.5 billion would amount to only 1.45 per cent of the current reserve stock and around 1.27 per cent of the projected reserve stock, it said.

"Thus, even under a constant 3 per cent hedging-cost assumption, the notional cost of the FCNR(B) swap remains relatively small compared with the size of the reserve buffer being built," SBI Research said.

The report said the cost is unlikely to represent a significant trade-off against the broader objective of strengthening India's external liquidity and reserve position.

SBI Research said the early closure of the FCNR(B) window came as a surprise to market participants, especially as in the last media interaction the RBI Governor had clearly indicated that there was no intention to close the scheme early.

"The most likely reason could be that the target for FCNR(B) mobilisation has already been achieved," it said. FCNR(B) deposits stood at USD 52.3 billion as of August 13, while total mobilisation under the facility, including overseas foreign currency borrowings and external commercial borrowings, stood at USD 56.8 billion.

SBI Research expects FCNR(B) mobilisation of USD 60-65 billion and total inflows, including OFCBs and ECBs, of USD 80-85 billion.

Despite the sizeable inflows, the rupee has barely responded to the FCNR(B) measures. SBI Research said the rupee's appreciation has been only around 0.1 per cent from the opening levels when the FCNR(B) scheme started. The report compared this with 2013, when the rupee appreciated 4.9 per cent between August 31 and November 30 and 8.8 per cent by March 2014 following the FCNR(B) swap window.

"While the magnitude of appreciation may differ from 2013 given the substantially different global and domestic macroeconomic environment, the direction of the impact is likely to remain supportive for the rupee," SBI Research said.