India’s successful attempt to attract foreign currency deposits from its overseas population could create a major cost challenge for the Reserve Bank of India (RBI), according to a report by Bloomberg.
The central bank’s special deposit programme received a stronger-than-expected response, with inflows expected to increase further after including overseas foreign currency borrowings and external commercial borrowings.
According to the report,economists estimate that the RBI could face a potential cost of up to $10.6 billion due to the initiative.
FCNR(B) scheme boosts inflows
The Foreign Currency Non-Resident (Bank), or FCNR(B), deposit scheme was introduced in June as a measure to support the rupee after it weakened to record lows. Under the arrangement, the RBI provided banks with a favourable currency swap facility to protect them against possible losses if the rupee depreciates.
The facility, however, comes with financial implications for the central bank. Economists estimate that the cost of currency swaps and managing additional liquidity in the banking system could reach around ₹1.2 trillion over five years.
A major challenge for the RBI is absorbing the additional liquidity created when banks convert foreign currency deposits into rupees. The central bank may need to use various tools to maintain balance in the financial system.
Despite these concerns, the RBI does not consider the cost a major issue at present. Officials believe repayment obligations can be managed as India’s foreign exchange reserves continue to strengthen.
RBI may offset expenses through foreign investments
Economists said the final cost will depend on how the foreign currency inflows are utilised. If the RBI invests the dollars in overseas assets such as US Treasury securities, the returns could help reduce the financial burden.
Investments in 10-year US Treasuries, which currently offer yields of around 4.7%, could potentially generate income that offsets the cost of currency hedging.
However, any reduction in the RBI’s earnings could affect the dividend transferred to the government. The central bank paid a record ₹2.87 trillion dividend to the Centre in May, and a lower payout could make fiscal management more challenging.
Experts have suggested that the funds raised through the diaspora programme should be deployed carefully to maximise economic benefits and minimise potential costs.
