Credit Suisse sees limited impact of FCNR redemption

Banks that had lent cash for subscribing to FCNR scheme would now pull back loans and at the same time, the RBI will pay the banks in rupees

Credit Suisse in a research report on Thursday said it expected the impact due to foreign currency non-resident (FCNR) redemptions in September to remain limited in terms of liquidity and exchange rate. But it should be beneficial for the bond market.

At the time of the scheme, banks had entered into a swap agreement with the Reserve Bank of India (RBI). Banks that had lent cash for subscribing to the FCNR scheme would now pull back  loans and RBI will pay the banks in rupees. Hence, liquidity won’t be an issue for the banking system.

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However, the nature of liquidity will be different as for the liquidity that the bank would receive, the lenders would have to account for Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), which was not the case back in 2013 as the $26 billion worth FCNR deposits were exempt from CRR and SLR.

Banks are now over invested in SLR securities and hence the SLR impact won't be obvious, but impact due to CRR would be visible. The net effect, therefore, would be that the banking system liquidity would witness a shortfall of only about Rs 12,900 crore, Credit Suisse estimated. Further, the RBI's plan of injecting Rs 90,000 crore worth of liquidity through open market operations and a narrower rate corridor, would limit the contagion.

However, impact could be seen in the foreign exchange hedging cost as RBI wouldn't need to transact much in the foreign exchange forward markets after the FCNR deposits mature. Currently, RBI's position in the forwards market is more than $20 billion to take care of the redemption.

The fall in hedging costs will help the foreign investors to hedge cheap in the market and would push up demand for Indian bonds.

"As they stop buying forwards, hedging costs may fall, making hedged returns on Indian bonds attractive again. Thus, the unwinding of FCNR deposits could play a role in potentially bringing down bond yields," Credit Suisse wrote in its report.