Oct 12, 2022

The 2013 RBI FCNR(B) Swap Window – Review & Takeaways

Prof. Ananth Narayan

The 2013 RBI FCNR(B) Swap Window – Review & Takeaways

In the wake of recent volatility in our currency markets, some commentators have – somewhat prematurely – recalled the extraordinary steps taken by RBI in 2013.

To recap, post the taper tantrum of mid-2013, besides other steps, the RBI announced two special swap windows in September 2013.

First, it offered to swap US$ raised by banks from foreign currency non-resident (FCNR) deposits of maturity 3-year and above into INR, at a concessional rate of 3.5% p.a., about 3.0% cheaper than the market at that time.  Second, it allowed banks to raise foreign currency funding and swap them into INR at a concessional rate of 1% below market.

Collectively, the two swap windows brought in US$ 34B at a crucial time for India, with US$ 26 bn raised through the FCNR route alone.

To reiterate, it is wholly unnecessary for the RBI to contemplate any such unconventional (and expensive) scheme now. While we could see continued US$ outflows, RBI still has plenty of FX reserves and our currency is still overvalued in REER terms.

Having said that, it is always prudent to review contingency plans.

Specifically, two aspects of the 2013 swap window against FCNR(B) deposits are worth reviewing.

First, while this window was presented as a scheme to raise Non-Resident Indian (NRI) funds, only a fraction of the $26B was true NRI money. The rest was overseas bank money lent to NRIs, flowing in as NRI deposits.

Second, the concessional swap allowed NRIs and banks extraordinary high returns at a significant (if hidden) cost to the country. This benefit was not on offer to other legitimate foreign currency borrowers in India, including our own quasi-sovereign infrastructure financing entities.

The Offer to the NRI

Let’s understand how this scheme really operated for the average NRI. Consider a Singapore-based NRI with $100,000 to deposit. The proposal her bank would have shown her in late 2013 would have looked somewhat like this:

Start with your original $100,000

Borrow an additional $900,000 from the bank in Singapore for 3 years, at 2% p.a.

Place the entire $1,000,000 as a 3-year FCNR deposit in Mumbai at 3% p.a., and put this up as collateral against your $900,000 loan.

On redemption of the FCNR deposit, pay back the $900,000 loan, and take back your net $100,000 principal.

Each year, you would earn an interest of $30,000 (3% on $1,000,000).

Each year, you would pay an interest of $18,000 (2% on $900,000) On a net basis therefore, each year, you would earn a net interest of $12,000 – or 12% on your original $100,000!

Some banks even went a step further and offered $1,900,000 of leverage for every $100,000 that the NRI put up, giving her an extraordinary US$ return of 22% for taking cross-border risk on India.

What was in it for the bankers?

The bankers – overseas and in India – managed a good deal as well.

A typical Singapore bank’s actual cost of 3-year US$ funds at that point in time was around 1%, so they would have earned a healthy 1% spread on a practically cash-backed risk-free loan to the NRI.

The India bank branch effectively raised cheap 3-year Rupee funds at about 7.5% using the subsidized RBI swap on offer, at a time when the Indian government bond yield itself was above 8.5%.

The NRI Scheme That Wasn’t

In summary, a bulk of the money that came in the form of FCNR(B) deposits during September – November 2013 was not magnanimous NRI money at all. It was overseas bank & institutional money funnelled in as leveraged NRI deposits.

For allowing us to project this – somewhat misleadingly – as diaspora money helping the country at a critical time, NRIs earned double-digit US$ returns on their true (much smaller) corpus, exceedingly high in relation to the cross-border risk that they undertook.

Both the overseas and local branches of banks participating in the scheme made extraordinary returns from the scheme as well.

Adjusting for all subsidies, India effectively raised 3-year US$ at about 5.00%, or 4.35% over 3year US Treasury yields at the time. This was a high (if hidden) price to pay. A sovereign bond at this yield would have been a public relations disaster.

Putting this in context

Of course, we must appreciate that the circumstances at the time were unique.

Our currency markets were in turmoil and issuing a Sovereign bond under such circumstances would have been risky. There simply wasn’t the time to arrive at the perfect scheme.

Overall, the scheme changed the narrative around our currency at a time when India was counted amongst the fragile five countries in the world. From RBI’s perspective, the realized actual cost over the life of the deposits turned out to be lower, since USDINR stabilized after the success of this scheme.

Having said that, with the luxury of time and hindsight now available, it is worth considering how future schemes could be designed should the need arise again.

Possible alternative structure – more equitable, more transparent, less costly

We must assume that during any future contingency as well, a direct sovereign issuance would not    be an option.

Perhaps an alternative way of structuring a subsidized USDINR swap window could be to offer it uniformly to all approved borrowing and deposit routes – including to banks, NRIs, and to entities eligible to raise External Commercial Borrowings (ECBs).

Besides being fairer, opening the window to all borrowers should bring down subsidy costs significantly. For the equivalent of the FCNR(B) scheme of 2013, such costs would arguably have reduced by 1%-2%, translating to savings of $250-$500 million per annum – material by any yardstick.

With the swap available to quasi-sovereign export and infrastructure finance companies such as IRFC/ PFC/ IIFCL/ EXIM, this could also help channelling of funds into productive investments. Arguably, such fund raises should be at least as important as raising pretend NRI deposits.

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