Friday, June 3, 2016

Forex market braces for volatility as FCNR deposit redemptions near

Last Modified: Sat, Jun 04 2016. 12 25 AM IST

Despite repeated assurances by RBI that it has hedged the inflows in the forwards markets, analysts are not convinced

Mumbai: The impact of the $25 billion redemption of foreign currency non-resident (FCNR) deposits between September and November is the latest disagreement between markets and the regulator regarding liquidity. Bankers are troubled over the outflow, despite repeated assurances by the Reserve Bank of India (RBI) that it has hedged the flows in the forward markets.

The currency market fears that a bout of volatility may hit the exchange rate and rupee liquidity as these deposits raised by banks in 2013 come up for redemption.

In September 2013 when the rupee was under pressure, banks raised $25 billion through FCNR deposits and another $9 billion through foreign currency borrowings and swapped the same with RBI. It's this $25 billion chunk of deposits that will be due between September and November.

Analysts are not convinced that the math has been worked out to perfection by RBI. A report released by Kotak Institutional Equities on Thursday said there is a $9.5 billion hole that RBI still needs to cover. Most of the $25 billion was raised through leveraged funds, which means banks offered customers loan money to put in FCNR deposits. Kotak says that since 85% of these deposits were made on borrowed money, most of them will not be rolled over.

Did RBI expect this? Yes. That's why it hedged the position in the forwards market. As of April, RBI's forward dollar position was negative $4.25 billion, down from a negative $32 billion in November 2013.

But Kotak said that RBI's forward position is likely to be net short by $9.5 billion for the crucial period of September-November.

This shortfall along with outflows of deposits from individual banks could lead to volatility in the currency and also in domestic liquidity conditions. To contain the volatility, RBI has been taking delivery of its forward position to boost reserves, said the Kotak report quoted above. "If this trend continues, it will help RBI boost its forex reserves to prepare before the eventual payout. Subsequently, reserves accretion will be nullified on maturity of FCNR swaps," said Kotak.

Markets are already pricing in this volatility, said Mathew Jones, head of technical research at Almus Risk Consulting, a forex advisory firm.

"There will be an impact in all three segments—spot markets, forwards market and the money markets. When leverage is unwound anywhere, it is bound to create volatility. For the spot rupee, volatility always hits to the weaker side," said Jones.

The rupee which closed little changed at 67.26 on Friday, has weakened 1.24% over the past one month. Year-to-date, the rupee is down 1.6%.

Jones said the technicals of the currency market could push the rupee towards 70.30 per dollar later this year. Global factors such as any further weakness in the renminbi, RBI governor Raghuram Rajan not getting a second term, or Britain's exit from the European Union could quicken the pace of depreciation on the rupee, said Jones.

RBI also has the option to allow banks to roll over these deposits, particularly if the global markets are choppy at the time the redemptions come up. In an article in Mint on Thursday, Indranil Sen Gupta, co-head and economist, India research, at Bank of America Merrill Lynch, said RBI will keep the door open for rolling over these deposits. Gupta also pointed out that individual banks may not be fully prepared to meet their payment obligations to RBI. Read here[1]

Ashish Parthasarthy, head of treasury at HDFC Bank Ltd, which had raised about $3.4 billion in FCNR deposits, said the bank does not anticipate trouble.

"We are comfortably covered for the FCNR redemptions. Overall, there is unlikely to be an issue with liquidity. We could see some volatility due to mismatch in maturities, but the RBI has said they would provide for the shortfall as well," said Parthasarthy.

However, Bank of Baroda, which had also raised a large chunk of such foreign currency deposits, said there will be some impact on liquidity and margins.

"It is a cheaper source of funding and anything cheap that goes out is not good for the system. We have about $1.7 billion worth of FCNR deposits and against that loans of about $1.3 billion in the overseas market. From the overall rupee liquidity perspective, that amount will go away. Logically speaking, this would show on the deposit number and the net interest margin number as well," P.S. Jayakumar, chief executive officer of Bank of Baroda, told Mint in an interview on 14 May.

Markets have rarely agreed with the regulator on the extent of liquidity for smooth functioning. The previous episode of disconnect was earlier this year when bankers kept complaining about the liquidity deficit thwarting their efforts of transmitting the central bank's rate cuts, but RBI held its ground that the deficit is not really hurting banks. The central bank eventually changed its stance on liquidity in its April policy and said it would bring the liquidity to neutral levels. This time, bankers are hoping the central bank would go beyond its customary assurances on the FCNR redemptions and keep the door open for rolling over of these deposits. Tuesday's policy statement would be read in this context as well.

First Published: Fri, Jun 03 2016. 09 46 AM IST


  1. ^ Read here (

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