(Manipulation by UPA to keep Rupee Strong Temporarily) All you wanted to know about FCNR (B) outflows. What is it?

(Manipulation by UPA to keep Rupee Strong Temporarily)

All you wanted to know about FCNR (B) outflows.

What is it?

The Indian rupee had tumbled to its all time low of 68.85 against the dollar in August 2013 as global financial markets were under fire after the US Federal Reserve announced that it would ‘taper’ its QE programme. To bring stability to the wobbly exchange rate, the RBI introduced a swap deal between September 2013 and November 2013 that was meant to encourage banks to attract sizeable dollar inflows in the form of FCNR(B) deposits. FCNR(B) stands for Foreign Currency Non-Resident (Bank) deposits.

Essentially, banks were encouraged to woo their NRI clients to deposit surplus dollars at a fixed interest rate, with the RBI promising to shield banks from the exchange rate risk. On receiving the dollars in 2013, banks were allowed to swap these funds with the RBI for a period of three years while paying a fixed cost of 3.5 per cent per annum. Banks handed over the $34 billion raised from the FCNR deposits to the RBI from Sep-13 to Dec-13, to receive the rupee equivalent under the swap arrangement.

So what happened in the deal process? Let us assume that 60 per dollar was the exchange rate fixed for the swap agreement. So the RBI would have given the banks ₹2,04,000 crore (60 * $34 billion) after receiving the $34 billion from them under the swap agreement. Now banks are obliged to swap back the sum raised with the RBI. The central bank will in turn provide the dollars needed for banks to repay their NRI depositors.

Government had built up a large enough kitty of forex reserves and also bought forward contracts on the US dollar to repay the banks. But if the parties who have sold those forward dollars to RBI are unable to pay up, they may have to step into the open market to buy dollars. This may spark volatility in the currency markets in the months ahead. The sudden outflow of capital from India could also tighten domestic market liquidity temporarily. The rupee has strengthened, but forex obligations been left for future.