The inflow of funds into foreign currency non-resident deposits (FCNR(B)) was significantly less than market forecasts. This impacted the rupee's exchange rate, which weakened by more than 1% against the dollar this week.
Pressure on the Rupee in July
After a 0.36% rise in June, driven by measures announced by the Reserve Bank of India (RBI), including a special period for FCNR(B) deposits, the Indian currency faced pressure in July. The cause was the sharp increase in global crude oil prices following the resumption of military actions between the US and Iran. On Thursday, the rupee performed worst among most Asian currencies, continuing its decline for the fourth consecutive week and reaching 96.35 per dollar, which is nearly a two-month low compared to the previous close of 96.27 per dollar.
Analysis of Decline Causes
Dilip Parmar, Senior Analyst at HDFC Securities, noted that the rupee was losing ground as recent support from the RBI waned, as well as due to sluggish interest in FCNR schemes amid rising global bond yields. Barclays also commented on the disappointing FCNR(B) flows in its report, stating that the positive effect of RBI measures to strengthen India's balance of payments and, consequently, the rupee, is beginning to fade, although they believe it is too early to judge their failure.
Government and Banking Sector Measures
Finance Minister Nirmala Sitharaman and RBI Governor Sanjay Malhotra held separate meetings with bankers during the week to assess the situation. Sitharaman instructed public sector bank heads to intensify outreach to Non-Resident Indians (NRIs) and introduce new deposit products to maximize fund attraction. Banks, in turn, reported receiving an encouraging response from the Indian diaspora.
Forecasts and Structural Constraints
Barclays does not expect a repeat of the large inflows seen in 2013, given higher rates in the US and less attractive rupee yields. They forecast that the reasonable base case for FCNR inflows in the coming months will be between $25 and $30 billion, with potential upside risks. Unlike in 2013, one key obstacle for the FCNR(B) scheme is the narrowing of spreads. A BofA Securities report highlighted that the interest rate differential between Indian banks' one-year FCNR(B) deposits and the yield on 12-month US Treasury bills has narrowed from 2.9% in 2013 to 1.4% currently. Nevertheless, BofA expects total inflows of $60 to $70 billion, believing that the inflow momentum will pick up in the coming days.
Prospects for Fund Mobilization
Madan Sabnavis, Chief Economist at Bank of Baroda, noted that in 2013, most funds arrived in the last month. He added that banks continue to adjust deposit rates based on market feedback, and the mobilization process is still ongoing. Gaura Sen Gupta, Chief Economist at IDFC First Bank, pointed out that creditors are still finalizing contract terms and arranging dollar financing for structured deals, which is slowing down mobilization pace. She suggested that, unlike the previous instance where 60-80% of flows occurred in the last month, there will be growth in August and September.
Factors Influencing Expectations
Expectations of strong mobilization were built on the RBI fully covering hedging costs, exemption from reserve requirements and liquidity ratios, as well as the precedent of the 2013 scheme and the potential for yield enhancement through structured instruments. However, Barclays pointed to the mismatch between deposit tenure and lock-in period as another structural constraint. While FCNR(B) deposits are typically attracted for three to five years, depositors can withdraw funds after one year of lock-in, depending on individual bank policies. Conversely, the RBI swap cannot be terminated before maturity, exposing banks to residual mismatch risk in case of early depositor withdrawal.
