The Reserve Bank of India (RBI) has caught financial markets off guard by prematurely ending a key incentive for foreign-currency deposits, raising significant concerns about its communication strategy. The central bank's decision to stop bearing hedging costs for Foreign Currency Non-Resident (FCNR) deposits after August comes less than two weeks after Governor Sanjay Malhotra stated publicly that no such proposal was under consideration.
Abrupt Reversal Fuels Market Uncertainty
The unexpected policy shift has had an immediate impact on Indian markets. The rupee recorded its largest decline in nearly a month, underperforming other Asian currencies, while yields on five-year government debt saw their biggest rise in over a month. Economists have highlighted the importance of clear central bank communication. Madhavi Arora, an economist at Emkay Global Financial Services Ltd., noted to Bloomberg News that “Markets can adjust to policy changes; what they find harder to price is uncertainty around the policy framework.”
Cost-Benefit Debate and Early Closure
The RBI's decision follows criticism regarding the FCNR deposit scheme's cost. Former RBI Governor Duvvuri Subbarao had recently described the deposits as expensive. However, some economists argued the central bank could absorb these hedging costs, given its substantial foreign-exchange reserves, which stand at approximately $700 billion. Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India, estimated the cumulative cost at around $10.5 billion, stating, “We don’t believe that the cost of swap could have been a constraining factor.” By August 13, FCNR(B) deposits had reached $52.3 billion, with total mobilization, including OFCBs and ECBs, at $56.8 billion. Bankers had anticipated another $25 billion to $30 billion by the end of August.
Operational Hurdles for Banks
The sudden closure has created considerable operational challenges for banks, which had planned their fundraising activities assuming the scheme would continue until September. India's largest lender, State Bank of India, had committed to raising $10 billion and had mobilized approximately $6 billion by early August. Banks now face the urgent task of redrawing their asset-liability profiles and accelerating paperwork for existing and potential clients. Attracting new customers under such short notice is particularly difficult, as opening FCNR(B) accounts and arranging overseas funds typically requires 15 to 20 days.