forex reserves: How RBI’s booster dose will fill up forex reserves and arrest rupee’s fall

The Reserve Bank of India (RBI) Wednesday took the first step to attract dollar inflows amid an unabated outflow of portfolio funds, seeking to salvage the sinking rupee from its lifetime lows against the US currency and conserve a fast-depleting foreign exchange stockpile assiduously accumulated when global liquidity was plentiful.

The central bank eased several curbs on the flow of foreign investments, including the terms governing the rates of interest offered to foreign currency deposits by overseas Indians. The threshold on External Commercial Borrowing (ECB) under the automatic route has also been doubled.

Furthermore, foreign portfolio investors (FPI) in debt securities will now have a wider choice of eligible instruments, while curbs on maturities have also been eased to draw more short-term funds amid a seemingly unidirectional flight of capital to dollar-backed assets.

“The Reserve Bank has been closely and continuously monitoring the liquidity conditions in the forex market and has stepped in as needed in all its segments to alleviate dollar tightness with the objective of ensuring orderly market functioning,’’ the RBI said in a statement. “In order to further diversify and expand the sources of forex funding so as to mitigate volatility and dampen global spillovers, it has been decided to undertake (these) measures.’’

The central bank, which was sitting on record high foreign exchange reserves toward the latter half of 2021, is dipping into the stockpile to arrest an unprecedented slide in the rupee. The Indian monetary unit has lost 6.26% this calendar year to the dollar due to the outflows. Foreign portfolio investors have withdrawn a record $30.34 billion until now this year, putting significant pressure on the rupee.

rupee

Shrinking Reserves

The reserves have shrunk nearly $50 billion from the peak of $642.45 billion reported in the week ended September 3 last year, although some of the depletion is due to revaluation of the central bank’s overseas assets. The US Dollar Index, or DXY that measures the strength of the greenback, is up 11.6% this year, data from Marketwatch showed. The outflow gathered pace with the US and other global central banks raising policy rates.

“The RBI measures are signalling regulatory preparedness to deal with further dislocation in the currency market,” said Ashhish Vaidya, managing director, DBS Bank India. “How much money will flow in will be a function of the landed cost of NRE or FCNR deposits versus domestic deposit costs. Institutions looking to garner a larger pool of funds will find these windows viable.”

The central bank permitted banks to garner FCNR (B) and NRE deposits from the Indian diaspora without any interest rate cap. Such relaxations are available until October 31 and November 4, respectively.

Also, FPIs can now invest in commercial papers and non-convertible debentures with an original maturity of up to one year. An FPI is mandated not to have more than 30% of investments each in government and corporate bonds with a residual maturity of less than one year. The short-term limit will be exempted for nearly four months.

Moreover, the Fully Accessible Route, a bespoke channel for debt investment by overseas investors, will expand its universe of government securities and include 7-year and 14-year papers.

The central bank created additional space for non-bank lenders tapping the offshore loan market, raising the highest ceiling to $1.5 billion from $750 million now. A local borrower availing the ECB route can also offer up to 100 basis points more to international investors; this threshold is currently capped at 500 basis points.

A basis point is 0.01 percentage point.

However, a borrower has to be rated at the investment grade to take advantage of this dispensation, available until December 31.

The RBI also allowed banks to expand the usage of overseas foreign currency borrowings (OFCB). A select category of banks can utilise OFCBs for lending in foreign currency to entities for a wider set of end-use purposes, the RBI said.

‘Gestation Period’

“The measures announced today are fundamentally good steps to attract capital, but may take some time to have an impact as the pressure on the rupee is primarily coming from the large, sticky current account deficit, and not just capital outflows,” said Rahul Bajoria, economist, Barclays.

The country’s banking system had attracted $30 billion in FCNR-B deposits through such schemes during the so-called taper tantrum, helping salvage the plummeting rupee and increasing forex reserves. The local currency was under pressure at that time following the US plan of slowing bond purchases.

Liberalisation of capital accounts began in India after the balance of payments crisis of 1991.

“The measures are intended to address depleting forex reserves and an adverse incremental credit-deposit ratio,” said Soumyajit Niyogi, director, Indian Ratings. “The surplus liquidity in the banking system has been reducing at a time when demand for credit has gained strong traction. If the pressure on deposits sustains, it will start adversely impacting credit flows to the real economy and also lending rates.”


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