With capital controls becoming a concern for several growing economies, there are reports that India – one among them – might react by adopting certain corrective measures including cutting interest rates on NRI deposits.
The Economic Times has quoted sources familiar with the proposal to say that a downward revision in the ceiling on interest rates offered on deposit schemes for non-resident Indians (NRIs) could be on the cards.
In the first half of the current fiscal year, NRIs remitted as much as $2.7bn into various non-resident accounts with banks. This is more than twice the amount remitted during the comparable period last year. More significantly, around 70 per cent, of their deposits are rupee-denominated. The latest data by the Reserve Bank of India reveals that most of the inflow took place between April and July.
Banks, particularly those with greater exposure to NRIs, have reported that huge inflows were being seen through various NRI deposit schemes. This move of overseas Indians is contrary to the trend that is being followed by the resident Indians.
As the banks have started decreasing the deposit rates, resident Indians are shifting their money to other investment avenues that they feel would yield greater interests.
The obvious incentive was the higher interest rates in India as compared to those in most of their host countries. As of now, the spread is Libor+175 basis points for NRE deposits and Libor+100 basis points for FCNR. Interest rates on foreign currency non-resident (FCNR) and non-resident external (NRE) term deposits are pegged to the London Interbank Offered Rate (Libor), the benchmark rate for global finance.
Traders have vouched that the NRI inflows were also triggered by the low dollar interest rates. In addition, FIIs and foreign banks were beginning to show renewed interest in government securities using the dollar as a carry currency.
The carry currency status was in view of the low cost of dollar liquidity that is currently barely one per cent. Domestic NRO deposits offered interest of six per cent for one year. With the possibility of currency appreciation the effective returns were nearer to about seven percent per annum.
Another major reason for the surge in NRI deposits was the robust health of Indian banks. While, NRIs had seen major financial institutions crumble under the weight of the global crisis, Indian banks remained solid and that much more reliable.
The third most significant factor prompting the NRI enthusiasm was the exchange rate. There has remained a strong likelihood of the rupee appreciating further, especially against the UD dollar and therefore against other currencies pegged to its rate.
Since September, the rupee has appreciated by over four percent against the dollar. This was despite the presence of the oil companies for purchase of the dollar. Besides, the RBI also intervened in the markets for preventing any major exchange rate appreciation. This is the first RBI intervention in the foreign exchange markets this fiscal year to moderate exchange rate volatility.
The RBI intervention, traders said, was mostly in the swap markets, through buy-sell swaps. The forward market intervention and oil companies’ purchases pushed up forward premia at the short and
middle end.
Bankers said the rupee was expected to appreciate further. By March 2010, HSBC and Standard Chartered expect the rupee to breach the 45 level against the US dollar.
NRIs park their funds in three schemes FCNR(B), NRE(RA) and the non-resident ordinary rupee accounts. The inflows under the first two schemes are repatriable while inflows under the last scheme are non-repatriable.
The central bank, the Reserve Bank of India, sets the interest rate ceiling on non-resident deposits, thereby, setting the trend for interest rates offered by banks on such deposits. Any reduction in these spreads would make its less attractive for non-residents to park their funds in such deposits.
However, there are reports that say the RBI would have to do this among others measures to deal with the issue of hot money.
India has seen foreign investment inflows of $27.5bn between April and August 2009. At this rate, the inflow of foreign direct and portfolio investment could cross the $61.6bn level of 2007-08, when India put limits on external borrowings and curbed the use of participatory notes to invest in the stock market as part of measures to curb the inflow of overseas capital.
