Why the RBI killed its own FCNR party three weeks early

On 8 June the Reserve Bank of India opened a cheap door for dollars.

Here is the deal in ordinary words. Indians living abroad can park dollars in Indian banks for a few years. Those accounts are called FCNR(B). The letters mean Foreign Currency Non-Resident. The money stays in dollars. It is not converted into rupees by the depositor.

Banks like those deposits. They do not like the risk that the rupee moves against them. So the RBI offered a swap. A swap here is just a locked exchange. The bank gives the RBI the dollars today. The RBI promises to give those dollars back later at the same rate. The bank pays nothing extra for that lock. That is what "at par" means. The first price and the return price are the same number, taken from the official FBIL dollar-rupee fix.

Two extra sweeteners sat on top. CRR and SLR are the cash and government-bond piles that Indian banks must normally hold. The RBI waived those on the new FCNR deposits. So a bank could use more of the money, not park it idle.

The window was meant for fresh three-to-five-year deposits. The bank could not cancel the swap. The deposit had a one-year lock-in. The official close was 30 September. Swaps could run a little longer.

Two smaller pipes were bundled in. ECB means a company borrowing dollars abroad. OFCB means a bank borrowing dollars from its own overseas arm. Those two stay open until 31 December.

Then the money showed up. $40.8 billion by 31 July. $56.9 billion by 13 August. $72.8 billion by 21 August. Of that, $65.4 billion was FCNR. The RBI brought the FCNR deposit cut-off forward to 31 August. Swaps on those deposits last until 11 September. ECB and OFCB were left alone.

The last time India ran this play was 2013, after the taper tantrum. That was the scare when the US talked about ending cheap money and the rupee slid. Banks then raised about $26 billion in FCNR and about $34 billion in all foreign-currency inflows, including overseas borrowings. This year's FCNR pot is more than twice that 2013 FCNR print. The Economic Times BFSI desk is the source for those 2013 figures.

Governor Sanjay Malhotra said as late as 5 August that there was no proposal to pull the scheme. Ten days later the RBI cited an "encouraging response" and shut the FCNR tap a month early. The Times of India said the inflows helped reserves rise nearly $10 billion in the week ended 15 August. Bankers expect the stock to pass the $728 billion high by end-August. Rediff, using PTI, had reserves at $707 billion by 7 August after a $14.14 billion weekly jump.

Think of the swap as a bribe for dollars. It works when NRIs and bank treasuries can lock a profit and dump the currency risk on the RBI.

Why did the RBI want the dollars? Forex reserves are the country's dollar savings. When the rupee is under pressure, the RBI sells some of those dollars to slow the fall. A bigger pile makes that easier. A bigger pile also looks calm to markets.

Why shut the door early? The RBI wanted a buffer. It got a flood. Floods have a cost.

Every dollar swapped at the same rate is a dollar the RBI may have to hand back later. If the rupee is weaker then, the central bank takes the loss. If the deposit leaves when the free hedge ends, the reserve number shrinks. These are borrowed dollars. They are not a factory, and they are not lasting foreign investment.

Cheap inflows also leak into domestic money. The bank sells dollars to the RBI and gets rupees. Those rupees sit in the system. Too many rupees can push prices up. That fights the same inflation the RBI is supposed to police.

So the early close is not only a victory lap. It is a central bank saying it has enough rented dollars for now. It would rather not keep paying for more.

Compare 2013. Then the rupee was in a proper scare, and $26 billion of FCNR felt like a rescue. This time the headline is $65 billion of FCNR before the window was even supposed to end. That is a different scale of dependence on NRI deposits. Those deposits are loyal until the hedge disappears.

I keep thinking about the politics of the reserve number. Crossing $728 billion makes a nice chart. It does not tell you how much of the rise is money that can be recalled. Maybe the RBI closed early because the chart was already doing the job. Maybe it closed because another month of this would have been too much cheap fuel in the system.

Banks have eight days to book more FCNR deposits, then until 11 September to swap them. After that the test is stay-or-go. If those deposits roll off when the free hedge ends, the $72.8 billion will look like a rental, not a reserve.

The ECB and OFCB pipes stay open till New Year's Eve. They will not replace this party.