The cost of the Reserve Bank of India’s (RBI) FCNR(B) swap facility is unlikely to have been a major factor behind the central bank’s decision to close the window for fresh deposits a month ahead of schedule, SBI Research said in its latest Ecowrap report.
The research report estimated that the cumulative hedging cost of the facility could reach around USD 10.5 billion over five years, but said this would remain relatively small compared with India’s foreign exchange reserve buffer.
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The RBI on August 14 announced that the window for fresh FCNR(B) deposits under the special swap facility would close on August 31, instead of the previously scheduled September 30.
Hedging cost remains small relative to reserves
SBI Research estimated that potential FCNR(B) mobilisation of USD 65-70 billion, combined with an average USD/INR hedging cost of around 3 per cent a year, would translate into an annual notional hedging cost of about USD 2.1 billion on a USD 70 billion corpus.
If the 3 per cent hedging cost remains unchanged throughout the five-year maturity of the deposits, the cumulative cost would amount to about 15 per cent of the corpus, or USD 10.5 billion, the report said.
However, the research house noted that the cost remains modest when compared with India's reserves. With current reserves at around USD 700 billion and incremental reserve accumulation assumed at roughly USD 20 billion a year, the five-year cumulative hedging cost would be equivalent to only 1.45 per cent of the current reserve stock and around 1.27 per cent of the projected reserve stock.
"Thus, even under a constant 3 per cent hedging-cost assumption, the notional cost of the FCNR(B) swap remains relatively small compared with the size of the reserve buffer being built," SBI Research said.
It added that the cost was unlikely to constitute a significant trade-off against the broader objective of strengthening India's external liquidity and reserve position.
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Early closure likely linked to mobilisation target
The RBI's decision to shut the window early came as a surprise to market participants, particularly because the governor had indicated during the last media interaction that there was no intention to close the scheme ahead of schedule, SBI Research said.
"The most likely reason could be that the target for FCNR(B) mobilisation has already been achieved," it said.
FCNR(B) deposits stood at USD 52.3 billion as of August 13. Total mobilisation under the facility, including overseas foreign currency borrowings and external commercial borrowings, stood at USD 56.8 billion.
SBI Research expects FCNR(B) mobilisation to reach USD 60-65 billion, while total inflows, including OFCBs and ECBs, could reach USD 80-85 billion.
Despite the sizeable inflows, however, the rupee has shown only a limited response to the FCNR(B) measures. SBI Research said the currency's appreciation was around 0.1 per cent from opening levels when the scheme began.
The report contrasted this with the 2013 FCNR(B) swap window, when the rupee appreciated 4.9 per cent between August 31 and November 30 and 8.8 per cent by March 2014.
"While the magnitude of appreciation may differ from 2013 given the substantially different global and domestic macroeconomic environment, the direction of the impact is likely to remain supportive for the rupee," SBI Research said.
