Knowledge Nugget: What are FCNR (B) deposits and swap scheme?

2. By absorbing the hedging burden, the RBI has made FCNR(B) deposits a more attractive source of overseas funding for lenders. Experts believe the steps announced may attract an additional $50 billion to $70 billion in foreign capital into Indian markets, provided the banks offer the right interest rates after considering the hedging sops.

3. This FCNR (B) swap scheme is revived after nearly 13 years with the vision that it will do much of the heavy lifting when it comes to bringing in foreign inflows. The facility is a plain buy/sell foreign exchange swap from the RBI side covering only the principal amount of the deposits and not the interest component.

4. The FCNR(B) swap scheme is even more potent this time around. In 2013, the RBI provided a 3.5% subsidy to banks. Now, it will fully bear the exchange rate risk on new three- to five-year deposits mobilised until September 30.

5. The latest FCNR(B) swap facility, whose guidelines were announced by the RBI on June 8, comes into effect immediately and will remain open up to October 16 for deposits mobilised until September 30. Banks would be free to price these deposits as per their internal policy, but within the overall ceiling as per the extant guidelines issued by the RBI.

Infographics by NotebookLM

6. The RBI says a bank can avail of the swap facility only once in a week. During any week, the maximum US dollars that a bank would be eligible to swap with RBI would be equal to all eligible FCNR(B) deposits mobilised in equivalent US dollar terms during the preceding week(s) for which the facility has not been availed earlier.

7. Banks can sell US dollars in multiples of $1 million to RBI and simultaneously agree to buy the same amount of US dollars at the end of the swap period. In the first leg of the transaction, the bank will sell US dollars to the RBI at the FBIL Reference Rate.

8. Under the framework, banks are also exempted from maintaining the cash reserve ratio (CRR) and statutory liquidity ratio (SLR).

What are the FCNR (B) deposits?

1. FCNR (B) are fixed-term deposits designed for Non-Resident Indians, Persons of Indian Origin (PIO), and Overseas Citizens of India (OCI). Such deposits allow account holders to park their earnings abroad in freely convertible foreign currencies without having to convert them into rupees.

2. These deposits allow overseas Indians to maintain their savings in designated foreign currencies such as the US dollar, pound sterling, euro, Japanese yen, Australian dollar, and Canadian dollar, rather than converting their funds into Indian rupees.

3. Interest earned on FCNR(B) deposits is exempt from income tax in India as long as the depositor qualifies as a non-resident under Indian tax laws. Under the current framework, banks can offer rates linked to internationally accepted benchmark rates.

4. According to the RBI, the FCNR(B) scheme was introduced with effect from May 15, 1993, to replace the then prevailing FCNR(A) scheme introduced in 1975, where the foreign exchange risk was borne by the RBI and subsequently by the Indian government. The FCNR(A) scheme was withdrawn in August, 1994 in view of its implications for the central bank’s balance sheet and quasi-fiscal costs to the Government.

BEYOND THE NUGGET: Withholding Tax

1. Amid pressure to attract foreign funds and also stabilise the rupee, the Centre has also scrapped the capital gains tax, both long-term and short-term, on investment by Foreign Institutional Investors (FIIs) in government bonds as well as the withholding tax they must pay on their interest income from these debt instruments.

2. Before scrapping, non-residents pay a withholding tax of about 20% on the interest they get on the government bonds they hold — one of the highest in the world — after a concessional rate of 5% ended in 2023.

3. A high withholding tax is seen as a major deterrent for foreign capital inflows at a time when India is grappling with rising external pressures, including a sharp surge in crude oil prices.

4. Withholding tax, or WHT, is a tax collected at the source of income. Instead of waiting for an investor or foreign company to pay taxes at the end of the financial year, the government requires the payer to deduct a portion of the income before it is remitted to the recipient.

5. The deducted amount is then directly deposited with the government. In simple terms, whenever income is earned — whether through employment, investments, royalties or other sources — the government ensures tax collection in advance through withholding tax.

Post Read Question

Consider the following statements:

1. Higher withholding tax leads to higher foreign capital inflow.

2. FCNR (B) are demand deposits designed for NRI, PIO, and OCI.

Which of the statements given above is/are correct?

(a) Only 1

(b) Only 2

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer Key

(d)

(Sources: Why RBI is returning to a ‘terrible’ idea to boost foreign inflows, FCNR(B) deposits: Why higher interest rates may be needed to bring in NRI dollars, India banks can lend against FCNR(B) deposits, says RBI)

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