scorecardresearch
Follow Us:
Wednesday, October 27, 2021

The story of the entry and exit of the high-cost FCNR Scheme

To bolster the rupee, the RBI offered to swap these funds for a minimum of three years at a fixed rate of 3.5%, leading to inflows of $ 34 billion, and helping stabilise the currency.

Written by Shaji Vikraman |
Updated: April 5, 2017 6:07:45 pm
The RBI had earlier this month announced that it will be coming out with concept paper on P2P lending, saying it has shown an accelerated growth over the last one year. One of the first things that the new RBI Governor, Raghuram Rajan, announced was that the central bank would offer a special concessional window for FCNR-B deposits.

In early 1994, as foreign exchange reserves rose from around $ 1 billion in June 1991 to $ 13 billion as a result of foreign direct investment, foreign portfolio flows and overseas equity issuance, the Reserve Bank of India flagged to the Finance Ministry a huge liability in the form of foreign exchange denominated deposits that were due to be redeemed that June.

This was the Foreign Currency Non Repatriable Deposit Scheme or FCNR-A, under which deposits were denominated in currencies like the US dollar and the pound sterling, at attractive rates, and with an underlying guarantee by the central bank to provide for any exchange rate losses. The RBI had to make good the difference between the exchange rate at which the deposits were booked and the rate when they were redeemed, making it a big draw for investors, especially in the Middle East.

The scheme was encouraged in the 1980s to boost capital flows and help fund the deficit on the current account at a time when inflows were limited to bilateral assistance, funds from the World Bank and institutions such as the IMF, and deposits from Non-Resident Indians. These deposits started swelling in 1982, after the government nudged the Reserve Bank to offer rates that were two percentage points higher than those on local rupee deposits. The RBI did object at that time, but was overruled — R N Malhotra, who was to later head the central bank, was at the time the Secretary, Economic Affairs. That year onwards, FCNR deposits rose — and by the end of March 1989, they had surged to Rs 8,255 crore. However, around 1990-91, after the Gulf war and the balance of payments crisis in India, there was a depletion of deposits — which were to be bolstered, however, after the opening up of the economy.

By 1994, the outstanding liability on account of these deposits had risen to over $ 10 billion — not counting the interest on them and the potential foreign exchange loss in the couple of years before that, when the rupee was devalued in 1991. That’s when Finance Minister Manmohan Singh, his Secretary in the Finance Ministry, RBI Governor C Rangarajan, and Deputy Governor S S Tarapore, started discussing the issue.

As India started gradually building up its foreign exchange reserves, both the RBI and the government recognised that these high-cost deposits needed to be phased out. There was the comfort of inflows from foreign funds who were buying into stocks of Indian companies, besides foreign firms bringing in capital to build units here and forging tie-ups with Indian companies. For the RBI, the worry was its balancesheet. Underwriting the losses on account of foreign exchange differentials would mean providing for it and reflecting it on its accounts and its prudential reserves, and indicating a broader impact. The central bank didn’t want to take the hit or show a loss.

And it wasn’t just banks. Many public sector institutions who were pushed to borrow in 1990 and 1991 by the government even when they had no need for such borrowings, too had to bear such losses. That’s when, after discussions involving the Finance Minister, the RBI Governor, and other officials, it was decided that the government would pick up the tab for that. If the bill was to be paid by the government, there wouldn’t be any worries related to provisioning, the central bank pointed out during the talks — a point that the government conceded.

So, in the Budget of 1994-95, the government decided to provide Rs 365 crore for taking on its books the liability on account of foreign exchange losses that were to be borne earlier by the RBI. The Finance Ministry and the RBI, in turn, came to an agreement that the central bank would raise the share of its annual transfer to the government progressively. And the Ministry and RBI then agreed in mid-1994 that the time was opportune to shutter the high-cost FCNR scheme.

As the scheme with its guarantees was being wound up, a couple of new schemes were introduced. Having learnt from the mistakes of the past, the central bank decided to allow banks to offer another scheme called FCNR-B — leaving it to banks to take on the exchange rate risks. This would provide for forex resources to banks to lend to their customers who might need foreign funding. To help banks, the RBI eased requirements, including on lending to the priority sector. Banks were quick to build up these deposits too, but with little worry for the central bank. That was till 2013 — when the Indian currency came under attack, and the current account deficit and fiscal deficit widened, in the final year before the UPA government left office.

One of the first things that the new RBI Governor, Raghuram Rajan, announced was that the central bank would offer a special concessional window for FCNR-B deposits. To bolster the rupee, the RBI offered to swap these funds for a minimum of three years at a fixed rate of 3.5%, leading to inflows of $ 34 billion, and helping stabilise the currency. Managing the redemption of these funds shouldn’t be a problem as may have been the case in the past with the build-up of reserves.

 

shaji.vikraman@expressindia.com For more articles in this series, visit the author’s microsite at The Indian Express web site, https://indianexpress.com/profile/ author/ shaji-vikraman/

📣 The Indian Express is now on Telegram. Click here to join our channel (@indianexpress) and stay updated with the latest headlines

For all the latest Explained News, download Indian Express App.

  • Newsguard
  • The Indian Express website has been rated GREEN for its credibility and trustworthiness by Newsguard, a global service that rates news sources for their journalistic standards.
  • Newsguard
0 Comment(s) *
* The moderation of comments is automated and not cleared manually by indianexpress.com.
Advertisement
Advertisement
Advertisement
Advertisement