The Reserve Bank of India on Friday moved to drain dollar flows from the banking system, fueled by the runaway success of its special foreign deposit scheme, by announcing plans to drain dollar flows from the banking system. ₹$1 trillion through open market bond sales. The central bank said it would sell sovereign securities in three tranches. ₹50,000 crore on September 17, followed by two proposals ₹25,000 crore each on 21st and 28th September.
The announcement was made after system liquidity exceeded ₹Earlier this month, $11 trillion was received and the RBI’s special window for foreign currency non-resident deposits (FCNR-B) attracted $172.2 billion in just two months. This prompted the central bank to withdraw excess liquidity amounting to more than ₹8 trillion through multiple floating rate reverse repo (VRRR) auctions. Currently, the liquidity of the system is estimated to be in surplus ₹10.4 trillion.
The announcement came hours after Governor Sanjay Malhotra said CNBC-TV18 that the RBI has “sufficient tools” beyond VRRR to manage liquidity, such as open market operations (OMOs) and swaps. “We will use the tools that we think will be most suitable. It could also be a combination of tools.”
Liquidity surplus
The central bank’s goal has always been to maintain adequate or compliant liquidity so that the operational target of the weighted average call rate (WACR) matches the repo rate, Malhotra said. “That will be our goal right now. You can see that it (WACR) is low due to excess liquidity. This liquidity needs to be withdrawn.” The WACR as of September 11 was 5.02%, which is lower than the current repo rate of 5.25%.
Some of that liquidity will be withdrawn on its own “over a period of time,” he said, given the need to support the foreign exchange market and higher reserve requirements for banks due to robust credit growth. The total volume of bank loans increased by 18.6% compared to the same period last year. ₹226 trillion as of August 15, according to the latest RBI data.
Asked whether raising cash reserve ratio (CRR) requirements for banks is also being discussed, Malhotra said “nothing is being discussed” and that the RBI is cognizant of the fact that CRR requirements have been waived for FCNR deposits. “We will be cognizant of that fact and obviously we will not have a higher CRR or CRR in any other form on these deposits.” Currently, banks are required to deposit 3% of their deposits as CRR with the RBI.
Cost to RBI
The hype around FCNR was largely due to the fact that the RBI had decided to bear the entire cost of hedging foreign exchange exposure on such deposits on behalf of the banks. While the dollar flow raised concerns about higher costs for the central bank, Malhotra disagreed.
“I don’t look at it as a cost. Some people say it is a cost etc., but we need to look at the balance sheet of the whole of India and not just the balance sheet of the RBI. It is not a cost in terms of spending, which is what the RBI is actually doing,” he said, adding that on a net basis, this will only lead to additional revenue and earnings for the RBI because any additional forex capital flows can be parked in government securities abroad and earn interest.
“Some people are comparing it to the benchmark three-year forward premium. I don’t think that’s the right way to do it. It’s not the right price,” he said, adding that because the market there is so thin and there are few trades during the year, it does not reflect the premium on such deposits. In terms of forward premium rates, analysts have pegged RBI’s hedging cost at 2.8-3.5%, representing the total burden ₹10-12 trillion.
“I think it was a fair price and it was important from the point of view of the Indian economy and the sustainability of the external sector,” he said, adding that, for its part, the RBI discussed the scheme with stakeholders and banks before its launch. About 48-50% of the flows were from 5-year deposits, about 42% from 3-4-year deposits and the remaining about 9% or so from 4-5-year deposits, he said.
Thus, flows under the scheme were “very resilient” and reflected foreign investors’ confidence in India’s “extremely strong macroeconomic fundamentals.” “At the same time, it demonstrates that we can get foreign flows, capital flows in a short period of time,” he said, adding that these flows will help the country in terms of financial stability and external sector sustainability. “We are quite pleased with the result.”
Revolving loan rates
On the recent draft regulations prohibiting non-banks from providing revolving credit, Malhotra said the central bank never intended to allow NBFCs to offer such products, adding that the draft proposal reiterates this position. The issue was brought to the attention of the NBFCs during the RBI’s annual supervisory process, he said.
In a draft circular issued on August 6, the RBI proposed to limit lending to NBFCs strictly to term loans, effectively barring them from offering revolving credit facilities such as flexible loans. The central bank has introduced these guidelines to mitigate systemic stability risks, prevent evergreen lending and address liquidity vulnerabilities of NBFCs. Malhotra, however, stressed that the RBI is taking into account stakeholder feedback and that the final norms may differ.
As part of their feedback, NBFCs, through industry bodies, sought clarity from the RBI on the definition of revolving credit and exemptions for certain products targeted at micro, small and medium enterprises (MSMEs), including supply chain finance and invoice discounting. Lenders have also asked the regulator to allow revolving credit lines, albeit with stricter underwriting and disclosure conditions to address any concerns, or to create a new structure for such credit products. Mint This was reported on September 2.
In an interview, Malhotra said the share of such loans is currently small, but a sharp increase could cause problems related to systemic stability and liquidity as they lack the liquidity support that banks have and this could ultimately impact financial stability.