In particular, we see the measures to fully subsidise FX hedging costs for FCNR(B) deposits, and importantly the removal of taxes on government bonds for FPIs as having the greatest potential impact for the Indian Rupee.
For context, the FCNR(B) measure was a key measure that was announced under RBI on 4 Sep 2013, under then new RBI Governor Raghuram Rajan. This policy subsidised FX hedging costs for banks to raise fresh Foreign Currency Non-Resident funds, drawing in US$26bn from this policy alone, and close to US$34bn from a combination of other measures as well (see Charts 6 and 7).
This measure worked very well back in 2013 due to two key factors. 1st, RBI’s FX hedge subsidy at 3.5% fixed (around 3% discount to prevailing market rates) significantly increased the incentives for banks to raise US Dollar funds from Non-Resident Indians, while investing domestically to earn a spread. 2nd Low US short-end interest rates in 2013 (~1-2%), and relatively high India yields (~9%) increased the incentives for banks and NRIs to borrow to leverage up to benefit from this spread, while importantly taking no FX risks due to RBI’s subsidy.
In today’s context, RBI has now offered to fully subsidise the FX hedging costs for fresh 3-5 year FCNR(B) deposits till 30 September 2026. This implies around a 3% discount to prevailing FX swap rates of 2.8% to 3.3% for the 3-5 year tenor.
With no FX hedge cost, we think the incentive for banks and NRIs to bring in additional US$ funds makes sense today for the FCNR(B).
Nonetheless, with short-end US rates much higher today (~4%) and longer-end INR yields relatively lower (~6.4% for 5-year), we think the economics is less attractive relative to 2013. This is both because FCNR(B) rates have to rise sufficiently to compensate for higher US dollar deposit rates, and also because borrowing to leverage up makes less sense given the higher cost of funds both for banks and for NRIs (see Chart 8 for an illustration).
As a base case, we are pencilling in US$20bn of funds coming in through this route. While this is substantial, the eventual quantum of funds may be lower than what we saw in 2013 in our view based on our preliminary assessment.
