BOMBAY, 25 August 2003 — Just ask anyone, maybe a layman on the roads of Bombay or an affluent executive living in a plush residence, what does the Non-Resident Indian (NRI) mean to him? Surpassing barriers of caste and standard of living, all almost unanimously say, “NRI is someone who walks out from the airport, gold chains and gold bracelets, mobile totting, tons of attitude and loads of accent, pushing luggage on the trolley, and generally looking very monied!”
Now that’s the image on the NRIs in India, like it or not! And going by the way in which the Reserve Bank of India (RBI) has been behaving, it too probably thinks the same — NRIs are monied lot!
It seems the NRIs are a bit peeved with the RBI. And this is because a few days back, RBI set a cap on the interest rate that banks can offer on non-resident (external) rupee or NRE deposit. Many believe that this move might put a stop to the torrential pouring of dollars from the NRIs. And still more feel that this move was taken mainly to rein in the runaway rupee. RBI said in its press release that the cap was imposed to bring in some consistency in the interest rates on NRI deposits.
The RBI said that the interest rates on fresh repatriable NRE deposits for one to three years contracted effective July 17, should not exceed 250 basis points above the London Inter-Bank Offered Rate (LIBOR)/SWAP rates for US dollar of corresponding maturity.
The maturity period of repatriable NRE deposits would continue to be one to three years and the interest rate as determined for three-year deposits would also be applicable in case the maturity period exceeds three years. The changes in interest rates are also applicable to repatriable NRE deposits renewed after their present maturity period. Banks were offering 6 to 7 per cent for NRE deposits and now with the cap on interest rates banks are forced to offer less than 4 percent.
This cap is a big disappointment with the NRIs as the NRE deposits offered the highest interest rate, higher than those in Gulf, US and other European countries. Interest rates offered by banks on NRE deposits were more or less on a par with interest rates on domestic rupee deposits. But now, not so.
India’s largest commercial bank, State Bank of India (SBI) immediately slashed their NRE deposit rate from 5 to 3.7 percent. By putting the cap, the central government has also closed yet another avenue for arbitrage opportunities arising from the wide difference in interest rates offered in India and those prevailing overseas.
India’s foreign exchange reserves currently stand at $84.7 billion. Last week, the government announced that it is prepaying debt of $1.5 billion in the immediate future. The government had prepaid $3 billion of debt to the ADB and World Bank in February. This certainly indicates that for now India is happy with its forex situation.
But the bone of contention, for now, with the NRIs remains. A one-year NRE rupee deposit yields 5 percent against 1 percent on a dollar account. Analysts put NRI inflows into rupee deposits at over $6 billion in 2002-03. This could fall to $4 billion as a result of the RBI edict.
There are the other analysts who say that if a depositor hedges the exchange risk by paying a premium of 2.5 percent on the one-year dollar, then the return will be zero. But if these accounts are left without cover, then one can gain.
Repatriable NRE deposits for one to three years, now do not offer a rate more than 2.5 percent above the LIBOR. This in terms of yield, translates into 3.75 percent — Libor is 1.2 to 1.25 percent — against 5-5.5 percent now. These changes also apply to deposit renewals.
Following this cap, banks brought down the interest rates and naturally, for some time, the NRI deposits might undergo a slack. And this is precisely what the RBI wants for now, rein in the galloping rupee.
The biggest blow is that NRIs are now no longer eligible to invest their monies in small savings instruments such as Public Provident Fund (PPF), National Savings Certificates (NSCs) and Post Office deposits. However, the existing NRI account holders would be allowed to retain their PPF or NSC investments until maturity, subject to such money not being repatriable.
With this move the government has shut the doors on all possible avenues offering arbitrage opportunities for those seeking to take advantage of the higher interest rates in India vis-à-vis those prevailing overseas. The government of India has clearly sent out a message that in the light of the swelling forex reserves position, it is in no mood to offer high interest rates to attract further inflows.
Investment analysts, based on these developments, say that mutual funds in India would see a strong surge from the NRIs as funds might offer better returns than an NRE deposit. Well, only time will tell, where the wind blows, or rather where the dollar flows!