Ways to deal with FCNR liquidity deluge

The deluge of forex into the country on account of the FCNR/OFCB/ECB scheme has been a blessing. It raises the forex reserves, which in turn looks healthier in terms of import cover. It adds to liquidity in a big way such that there is discussion on how to deal with surpluses. The final number after the non-FCNR flows are reckoned could well cross $150 billion after the announced $137 billion garnered so far. What does it mean to all the parties concerned? For the RBI, the inflow of $137 billion means approximately 20 per cent increase in reserves from the level of $682 billion as of June 5. This can be used for several purposes. First, it can be used for spot interventions in the market as and when required. Second, it can be used to square off forwards books which stood at $103 billion as of June 30. Third, it can be invested in US treasuries or any other asset as per the policy being pursued. There could be a return of 4.7-5 per cent on these investments depending on the tenure of investment. There is, however, also a swap cost for the central banks which can be around 3 per cent. With a round ₹13 lakh crore being given to banks for the swap of $137 billion, there can be a cost of ₹39,000 crore on an annual basis. This will however be covered by the investments in US treasuries, thus giving a positive net return. This will be positive for the income and expenditure statement. On the other hand, given a larger balance sheet, the contingency buffer to be maintained increases in value terms, which can counter this increase in revenue. Also, if the RBI sells its holdings of GSec to manage liquidity then the interest earned from them would come down. Hence it needs to be seen if the surplus to the government can be maintained under ceteris paribus conditions. Issues for banks For banks, the issues will be different. They have procured clean funds at the cost of 6.25-7.25 per cent for five years. This higher amount of ₹13 lakh crore in dollar terms would entail an interest outgo of say ₹87,750 crore. The swap cost of hedging this interest at 3 per cent would be around ₹2,600 crore as this is not covered by the central bank. Now these funds have to be deployed in either lending or investments. Presently the weighted average lending rate on loans is 8.52 per cent for all banks, which means that there can be a spread of about 1.75 per cent, assuming average cost of 6.75 per cent. The surplus of ₹13 lakh crore in the system has implications for the markets. These funds would be used to manage the loan book without seeking recourse to bulk deposits or certificates of deposits. Hence these two markets will get depressed. Increasing the CRR through an incremental CRR may not be fair for banks which have not been aggressive in collecting such deposits. MSS issuance is a way out which can be used to support the fiscal deficit thus obviating the need for fresh borrowing. OMOs are also likely where RBI sells its holding of government paper. The last is VRRR on a rolling basis — which will be an inferior solution for banks as the returns are the lowest. Bond yields Curiously, markets have been quite unmoved with the bond yields remaining where they are with expectations of a rate hike in future. The rupee has strengthened now, more out of sentiment. The dollars garnered will not directly affect the market as long as they are used to build reserves. If they are sold in the market, then it will help to strengthen the rupee. The scheme raises some interesting ideas for further discussion. First, should the FCNR scheme be used periodically whenever it is felt that there is some slippage in the forex reserves? Based on the way in which the scheme was started and terminated early due to its success, a target sum can be announced such that the swap cost taken on by the RBI is, say, $50 billion. Once this level is reached, the scheme can be stopped.The RBI can ask other central banks to invest in bonds issued by Indian banks in dollars, guaranteed by RBI, with a higher return than offered by the Fed. The protocol can be akin to FCNR, with similar spin-offs. The writer is Chief Economist, Bank of Baroda. Views are personal Published on September 7, 2026