With RBI governor Raghuram Rajan springing a surprise on Saturday by announcing his unwillingness to continue at the helm of the Central bank beyond September 4, it might not just be the redemption of foreign currency non-resident (FCNR-B) deposits that market participants are worried about. There may be bigger concerns about the unanticipated outflow of funds by the foreign portfolio investors following the news, which could have a deleterious impact on the value of the rupee.
Experts feel that redemptions relating to FCNR-B deposits was known and the RBI had even planned for it. “Rajan had provided a lot of comfort to FPIs on the currency front and that resulted into huge inflow into the Indian markets. However, now that he has decided to move on, things may not remain the same and there will be FPI outflow because there will be fear of currency volatility,” said the chief investment officer of a leading mutual fund on conditions of anonymity. He added that while the FCNR related redemption is a known devil and is something that the market was prepared for, the market was not prepared for volatility that may follow Rajan’s exit.
On June 7, even Rajan has said that redemption of FCNR deposits raised in 2013 could lead to outflows to the tune of about $20 billion and pointed that RBI will provide dollar and rupee liquidity if needed to prevent any disruptions in the market.
Soon after Rajan took over in September 2013 (at a time when rupee was under pressure and had hit a low of 68.8), one of the first announcements he made was a special concessional dollar swap window to attract FCNR deposits and foreign currency borrowings. Following this, banks raised a total of $34 billion — $25 billion through FCNR deposits and $9 billion through foreign currency borrowings. Experts say that the $25 billion, raised through FCNR deposits and linked to borrowed funds will be due for redemption in September and November this year and will lead to an outflow of $20 billion.
FCNR deposit is where NRIs or Indian nationals are allowed to hold fixed deposits in banks in foreign currency thereby safeguarding them against any adverse currency volatility which they may get exposed to when they hold deposits in Indian rupee.
A debt market expert said that the most important aspect that FIIs consider while investing in an economy is the stability of currency and since Rajan had provided them that comfort, his exit may trigger some outflows which may make the rupee volatile.
“The most important market to be looked tomorrow and in the near term is the currency market. If the rupee is stabilised over the next 2-3 months, it would be said that the damage has been controlled, however, if it doesn’t then the credibility will be questioned,” said the expert.
The market has already witnessed some outflows on account of the anticipated hike in interest rates by the US Federal Reserve. While there was a net inflow of Rs 6,418 crore in the Indian debt market in April 2016, the month of May witnessed a net outflow by the FPIs amounting to Rs 4,408 crore. In this month (till June 17), the net outflow stood at Rs 1,260 crore. Experts feel that this is likely to jump if the currency becomes volatile.
The CIO quoted above pointed that since currency stability and inflation are key considerations for FPIs to invest in any economy, the new governor will have to tread on the path similar to Rajan’s and keep inflation and currency stability as target areas.