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The scheme has become a huge success with some USD 5.6 billion already flowing in, in just about 2-3 weeks. Foreign banks have been offering huge loans to their NRI clients and they have been swapping the money with RBI thus making big margins on this product.
The provocative proposition is that there is a national cost involved in that RBI has to pay back the dollars in one, two or three years. In fact every time the country piles up a large current account deficit (CAD) and the rupee depreciates rapidly, the country begs for dollars from foreign institutional investors (FIIs) or foreign banks giving them huge sops like don't pay taxes if you are investing through Mauritius, no withholding tax or through this current FCNR scheme which benefits foreign banks hugely.
So, is the country paying too much? Should we withdraw this product as quickly as possible as stability has returned?
Neeraj Gambhir, co-head of fixed income at Nomura, says the FCNR (B) as a product was always there, the pricing benefit has improved substantially but it was always there as a product and nobody was marketing it as aggressively because other NRE products were available. Now leverage is a key factor and obviously when it comes to availing of leverage it is the foreign banks which have an advantage because they can use their home country balance sheets or parent balance sheets to provide that leverage, he says. Though, even private and public sector banks have been able to garner significant amount of these deposits, he adds.
Dr Soumya Ghosh, chief economist at State Bank of India , believes the government and the Reserve Bank should have used this time to push through some of the reforms because there is a possibility of another bout of volatility in the rupee. He says: "Right now, we have got a very lucky break because of the US government shutdown and also the QE tapering which may not happen this year."
Below is the verbatim transcript of Neeraj Gambhir & Soumya Ghosh's interview on CNBC-TV18
Q: Neeraj let me understand the cost or the advantage to a bank. How much does a bank make when it brings money through the FCNR scheme?
Gambhir: The percentage benefit will differ from bank to bank because of their funding cost. The 3.5 percent subsidy is fairly clear and upfront to everyone but the other aspect of it as in the impact of the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) costs, the cost of the priority sector not being there I think it will be quite different between lets say the public sector banks and the private sector banks. But the guess is that approximately 1-1.5 percent drag normally comes on account of these statutory requirements. So, you could think that approximately 5 percent is my guesstimate across the system of the price benefit that people are getting of substituting their domestic liabilities with FCNR (B) liabilities. That is a significant price benefit to the banking system.
Q: Is it easier for a foreign bank than for Indian banks to get these NRI clients and hence benefit from this 5 percent butter and jam?
Gambhir: To a large extent the product is basically driven by leverage. The FCNR (B) as a product was always there and the pricing benefit has been improved substantially but it was always there as a product and nobody was marketing it as aggressively because the other NRE products and everything was available. Now leverage is a key factor and obviously when it comes to availing of leverage it is the foreign banks which have advantage because they can use their home country balance sheets or parent balance sheets to provide that leverage. So, we do see that there is a benefit or there is a higher capacity in the foreign bank system to provide that kind of a leverage.
Having said that what we believe and what we have heard in the street is that there are lot of private sector banks and public sector banks as well which have been able to garner significant amount of these deposits. So, may be that leverage providing has not just happened on banks on balance sheet but also for other banks products.
So, the ability of a particular bank to be able to draw money under this particular scheme is dependent upon their own distribution network and their capacity to provide adequate funding using the home country balance sheet.
Q: One of the problems that occur when a product is very successful, for instance we hear from the RBI that already USD 5.6 billion has come in through the FCNR and other banking capital window. Does the success of the scheme remove the pressure on the government to reform?
Ghosh: You are correct to some extent because if you look at the way the rupee has moved, today it has actually touched 61.4/ USD something like that and the rupee has appreciated so clearly there has been subsequent capital inflow into the country. I think some of the measures, if I take the example of the last year September when the government went ahead with Rs 5 diesel price hike and now exactly it is going for a Rs 0.50 and a Rs 3 cut in petrol.
My point is that at a later point of time if suppose again another bout of volatility in the rupee arises which may be a possibility because right now we have got a very lucky break because of the US government shutdown and also the QE tapering which may not happen this year. So, from that point of view we should have actually used this window to push through some of the reforms.
My personal sense is that may be we could actually cross subsidy even if we are unable to raise the diesel prices to that extent.
Q: The point is that, the pressure to raise one time that Rs 3 or Rs 5 is taken off, therefore the scheme actually is not being used in the way.
Ghosh: Actually that is another cost because if you look that is an indirect cost because if you are postponing the fuel price hike that is also going to add to the oil subsidy. So, if we have a budgeted oil subsidy of around Rs 40,000-45,000 crore and the estimates say today it can go up to anything to Rs 80,000-90,000 crore. That is an indirect cost that is also happening because we are unable to do the price hike.
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