Prasanna Tantri, an associate professor of finance at the Indian School of Business (ISB), has highlighted a significant potential risk for the Reserve Bank of India (RBI): a $200 billion forward dollar exposure stemming from foreign currency non-resident (FCNR) deposits. Tantri's warning comes as India's foreign exchange reserves have declined, prompting him to advocate for proactive policy measures.
RBI's Forward Dollar Exposure and Declining Reserves
Professor Tantri's concern centers on the RBI's net forward dollar short position, which he states has reached $200 billion. This substantial commitment coincides with a notable drop in India's forex reserves. After peaking at approximately $786 billion following special concessional swap facility inflows, reserves have fallen to $721.016 billion, a reduction of nearly $65 billion from their September high.
FCNR(B) deposits allow non-resident Indians to hold funds in foreign currencies with Indian banks. Under a special swap arrangement, banks raised foreign currency funds and entered into forward transactions with the RBI, creating future dollar obligations for the central bank. Tantri cautions against the assumption that these FCNR funds remain untouched within the reserves, ready for comfortable return upon maturity.
Proposal: Convert $50 Billion to Rupee Investments
To address this growing currency exposure, Tantri has proposed a voluntary program to convert at least $50 billion of these foreign currency non-resident deposits into long-term rupee investments. The objective is to retain overseas capital within India beyond the maturity of the foreign currency deposits and simultaneously reduce the RBI's corresponding dollar commitments.
Incentives for Conversion
Tantri suggests offering attractive incentives to encourage depositors to voluntarily shift their holdings. These could include:
- Higher interest rates on rupee deposits to compensate investors for accepting currency risk.
- Concessions encouraging investment in India's housing and equity markets.
- Faster approvals and priority in transparent land allocation.
- Reduced duties or taxes on domestic investments.
A crucial aspect of this proposal is that any conversion must also unwind the RBI's corresponding forward dollar obligations. Without this adjustment, merely shifting the underlying investments into rupees would not negate the central bank's existing foreign currency commitments. Tantri stressed, “The objective should be to retain capital, support investment and reduce the RBI’s currency exposure, with incentives costing less than the risks they remove.”
India's foreign exchange reserves saw a decline of $5.011 billion in the week ending October 16, following an $8.578 billion drop in the preceding week. Tantri emphasizes that while there is still time before these deposits mature, work on a credible conversion plan should commence immediately.