RBI's Move to Attract Foreign Currency Deposits
The Reserve Bank of India (RBI) attempted to draw capital flows by allowing banks to offer higher interest rates on foreign currency deposits for a specific period. However, the initiative has not been widely adopted since its announcement.
Interest Rate Adjustments
- The RBI temporarily increased the interest rate ceiling on Foreign Currency Non-Resident (FCNR) accounts.
- Banks were permitted to raise deposits with a spread of 400 basis points (bps) over an Alternate Reference Rate (ARR) for one to three years, up from 250 bps.
- For deposits of three to five years, the spread increased to 500 bps over ARR, from 350 bps.
Challenges in Attracting Depositors
- The rupee's depreciation and narrowing interest rate gap between the US and India have made attracting depositors challenging.
- Most banks have not raised interest rates despite the RBI's leeway, maintaining rates below the previous ceiling.
Banking Sector Response
- Some niche private banks may benefit from the plan due to their focus on overseas Indians.
- Banks match such deposits with foreign currency loan requirements, but the falling rupee and forex risk make this less economical.
Foreign Exchange Reserves
The RBI's move aims to boost foreign exchange reserves, which have declined by $60 billion since their peak in September due to RBI's dollar sales to support the rupee.
Current Interest Rates and Trends
- The spread between US and Indian interest rates is at its lowest, making Indian foreign currency deposits less attractive to the diaspora.
- The State Bank of India (SBI) offers 5.35% on one-year dollar deposits and 3.90% on five-year FCNR deposits, both lower than the revised spreads.
Future Considerations
Revised caps on interest rates are applicable until the end of March 2025. The Cash Reserve Ratio (CRR) exemption on incremental FCNR deposits might encourage banks to raise rates and attract more foreign exchange flows.
Historical Context
The FCNR (B) plan, initiated in 2013 by then-Governor Raghuram Rajan, allowed banks to mobilize nearly $30 billion in overseas deposits by providing a cushion against currency movement risks.
