he RBI’s early closure of its special FCNR(B) deposit swap window has raised concerns over policy certainty. Banks had mobilised $52.3 billion under the scheme by August 14, prompting the RBI to shut it on August 31 instead of September 30. Bankers say the move could disrupt dollar borrowings and leverage plans, while raising questions about India’s investment-policy predictability.
The Reserve Bank of India’s abrupt decision last Friday to shut a special foreign currency deposit swap window a month ahead of schedule raises an uncomfortable question about policy certainty. That matters because the scheme was designed to attract foreign currency inflows when India is trying to position itself as a more reliable destination for overseas capital.The regulator said banks had raised $52.3 billion through foreign currency non-resident, or FCNR(B), deposits between June 8, when the window became operational, and August 14. More strikingly, the RBI said the “encouraging response” meant the at-par swap facility would close on August 31, instead of the original September 30 deadline.
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The window was attractive for two reasons. First, the RBI effectively absorbed the entire currency hedging cost. Second, the regulator permitted leverage trades, allowing banks to lend to NRI customers in multiples of the capital they brought in as deposits.
The arithmetic was compelling. For NRIs, returns are as high as 16%-18%, since banks charged lower rates on loans (used to create deposits) than the 6%-7.5% interest paid on the deposits. Interest income is also tax-free.
The early withdrawal of the special FCNR deposit facility rattled bankers because barely ten days ago, Governor Sanjay Malhotra, responding to a direct question on whether the scheme could be closed prematurely since there was a cost attached to it, said: “As of now, there is no proposal under consideration to close the scheme prematurely.”
That makes the timing awkward. The early closure comes as India is trying to present itself as a predictable and attractive investment destination. The government has been focusing on ease of doing business, cutting taxes paid by foreign portfolio investors on government securities, widening the scope of special securities under the fully accessible route, and simplifying foreign investment rules. Markets regulator Sebi has also proposed easing KYC norms for NRIs and foreign nationals to encourage greater participation in Indian markets.
The U-turn risks sending an unhelpful signal for a country that needs durable foreign investment to stabilise the rupee and bridge a current-account gap widened by a rising energy import bill following the West Asia conflict.
There is an added irony. The move comes just ahead of PSB Manthan, the annual two-day summit scheduled for August 17-18, where public-sector bank chiefs are expected to discuss measures to attract foreign investment. At the summit, bank CEOs are likely to lobby with senior officials from the RBI and the finance ministry against shutting the swap window ahead of time.
The practical difficulty is that many banks have lined up dollar borrowings as seed capital for leverage on FCNR deposits. Several have agreed to pay a higher premium as dollar demand from India intensified after the RBI launched the special scheme.
Bankers say it typically takes 10-15 days from raising funds to creating an FCNR deposit through the leverage facility. The early closure leaves lenders with a difficult choice: absorb narrower margins or rejig leverage based on dollar availability.
The shift is also at odds with the initial official push. When the scheme was launched, the finance minister and RBI Deputy Governor Rohit Jain separately urged bank chiefs in closed-door meetings to put their best foot forward in attracting FCNR capital.
Some argue the overwhelming response ran counter to economists’ feedback to the central bank before the launch. Unlike in 2013, the India-U.S. interest-rate differential is narrower this time, at 2% against 6%, making meaningful inflows less likely. That may have prompted the RBI to keep the window open for four months, instead of three in 2013.
There were other risks too. The cost of raising funds could prove high when payments fall due three to five years later. Second, despite the dollar inflow, the local currency has not strengthened meaningfully while the RBI continues to intervene to ensure orderly movement in the rupee.
Those are justifiable reasons for reassessing the window, but a surprise U turn could have been avoided.
India has seen reasonably good inflows of durable capital in recent months, particularly into financial services. This can be sustained so long as investors have confidence in three things: that rules will not change unpredictably, that returns can grow, and that the rule of law will be upheld.
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