[Economy] FCNR Rate Hike to Prevent Rupee Downfall: Meaning, Implications, Explained

[Economy] FCNR Rate Hike to Prevent Rupee Downfall: Meaning, Implications, Explained

  1. What is FCNR?
  2. Example SBI FCNR
  3. What does SBI do with foreign currency?
  4. Why is FCNR in News?
  5. Implication of FCNR interest Rate hike

What is FCNR?

  • Foreign Currency  Non-Resident (FCNR) scheme was launched by RBI in the early 1990s.
  • It allows NRIs to make fixed Deposits (FD) in Indian Banks, in Pound Sterling, US Dollar, Japanese Yen, Euro etc.
  • They don’t need to convert their foreign currency into rupees, just directly deposit foreign currency in Indian Banks.
  • They don’t need to pay income tax on the interest earned in such account.
  • RBI decides the ‘upper ceiling’ on interest rate to be paid on such deposits.
  • Minimum maturity at 1 year, max is 5 years.
  • Example SBI FCNR. You can read its terms, conditions and features by clicking Me

What does SBI do with foreign currency deposits?

  • NRI deposits his hard earned dollars$ into SBI account.
  • SBI gives these dollars as loans to Indian Importers, who have to make payments in dollars for the importing raw material, machinery and goods from foreign countries.
  • SBI also gives these dollars as loan as pre-shipment credit to Indian Exporters. Because they’ve too may need to import some raw material from third country, also for paying the transport cost to ships etc.
  • In short, SBI (or any Indian Bank), takes dollars from NRIs in FCNR account and gives it as loans to Indian businessmen for import/export.
  • Same thing for Yen, Pound, Euro etc. (Because NRI can deposit those currencies as well and those Indian businessmen may also need Euro/Yen for making special purchases from particular country.)

Why is FCNR in News?

  • As usual, Rupee is weakening against dollar.
  • On 4th May 2012, the exchange rate was $1=53.** Rupees.
  • RBI had to do something immediately to stop the further downfall of Rupee against Dollar, so RBI chief increased the upper ceiling of FCNR interest rate. Now Indian banks can offer even higher interest rate on FCNR deposits.

 

Implication of FCNR interest Rate hike

  • Currently Citibank USA offers only 0.05% interest rate on savings account! (does it sound ridiculously low? Well, these rates are given on the official page of Citibank USA!
  • Compared to that, Bank of Baroda’s FCNR interest rate on dollar deposits is around 3 to 4%. Now they’ll increase the interest rate even higher, after RBI increased the ceiling.
  • So, the NRIs will find it even more attractive to park their dollar-savings in Indian banks rather than in American banks.
  • This Means, Supply of dollar increased for those Indian banks.
  • They can loan these dollars at to Indian importers. (more money supply =more liquidity = loan-interest rates go down).
  • Thus “Demand” of Dollars decrease @Forex market, because now you can borrow dollars from SBI @ a lower cost compared to what SBI used to charge earlier. So no need to run to Forex agents.

Imaginary example:

Year 2001

interest given to NRI on savings deposit: 3%
loan interest charged from businessmen: 6%

Year 2002

interest given to NRI on savings deposit: 4%
loan interest charged from businessmen: 5.5%

It seems the profit margin declined in second case, isn’t it? But the “volume” of incoming money has increase and so will the volume of business.
Besides, it takes only one troubled bank to reduced its loan interest rate, and the other banks will be forced to reduce their loan-interest rate as well, to stay competitive.
Then why didnot the said troubled bank reduce its loan interest rate earlier? because earlier its incoming NRI-deposits were low due to FCNR limit so they didnot have enough “raw-material” to reduce the sales price and yet run operation smooth.

      Demand of dollar decreases from open Forex market= rupee strengthens.

 

  • So instead of going down to $1=54 Rs, now rupee will trade @$1=52Rs or lower
  • Although it’s not that linear and immediate, takes some time for the laws of supply and demand to show effects and then rupee will start strengthening again.

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