In a bid to eliminate opportunities for arbitrage between the local and international forex markets, the Reserve Bank of India (RBI) has decided to include the overnight investments of banks from the nostro accounts within the 15 per ceiling on investments in overseas money markets.
This step is part of a series of reversals to the busy season monetary policy since December 2 by the RBI to reduce volatility in the forex market. In the credit policy, the RBI had allowed banks to borrow and invest up to 15 per cent of their unimpaired tier-I capital in overseas markets. The latest move is expected to bring back some of the dollars held abroad for speculative purposes.
Investments of nostro funds arising out of foreign currency accounts like foreign currency non-resident (banks), resident foreign currency, and exchange earners foreign currency accounts will continue to be outside the limit. Banks are expected to ensure adherence to the limit by January 7, 1998.
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It has come to the notice of the RBI that the overnight investments out of nostro accounts have become sizeable on a continuing basis. It has, therefore, been decided that the cap of 15 per cent permitted for overseas investments would also include overnight investments out of nostro accounts, said a press release issued yesterday by the RBI.
Through nostro accounts, banks invest in the overnight market to avail of overseas interest rates. The funds are then sold back in the spot or short forward market to avail of the premia benefit.
In October, the RBI allowed banks to borrow from, and invest in, overseas markets up to a maximum extent of 15 per cent of their unimpaired tier-I capital. Before October, banks were allowed to borrow up to $10 million from overseas markets for use in India.
The RBI had at that point decided that investments of nostro funds arising out of FCNR (B) deposits, EEFC, RFC, and escrow accounts and overnight investments would be outside these limits.
The higher limits were expected to ensure greater integration between domestic and overseas money markets. Banks were expected to arbitrage between call money and overseas money markets, thereby bringing the rates in alignment.
In line with expectations, led by foreign banks, public sector banks including SBI, Bank of Baroda and Bank of India took the bait and played the arbitrage game.
Call rates were ruling low while the prevailing cash tom, tom spot and cash spot rates were attractive enough for banks to make easy money. Although the RBI hiked the repo rate to make funding such a position by borrowing from the call market unattractive, higher call rates failed to deter funds-flush nationalised banks.