Yesterday, RBI cuts MSF rate by 50 basis points (0.50%) which was inevitable indeed. It tightened the short term rates couple of months back and tried hard to curb the liquidity in the market so that the banks should not speculate against the US Dollar. Now the MSF rate stands at 9 percent.
One of the major factor which helped RBI to cut down the MSF rate is the “no tapering” decision by US Fed which in turn helped not only Indian Rupee but other EM currencies as well. “No tapering” or continuing in QE policy is bad for dollar as it will weaken dollar against other currencies.
Cut in MSF rate is most welcomed part but the most exciting part is the new FCNR swap offered by RBI to the Indian Banks.
The FCNR account (abbreviated as Foreign Currency Non-Repatribale accounts are offered by Indian banks to the NRIs) is a term deposit account meant only for NRIs. The Indian banks accepts only those currency deposits which are freely convertible i.e.US Dollar, British Pound (Sterling), Japanese Yen, Australian Dollar, Canadian Dollar, Swiss Frank.
The FCNR account can be open for minimum 1 year and maximum of 5 years term. An NRI can use the deposit balance to make local payment and yes the interest rate fetched will be tax free in India.
As the Indian banks raise funds through FCNR channel, they take the deposits in other currencies and exchange that with Indian Rupee in the market with prevailing forex rates for domestic lending.Once the term of deposit is over they return the fund with promised interest rate. Since the deposit term ranges from 1 year to 5 years, they hedge FCNR deposits by entering into the derivative market (Forwards contacts, NDFs etc).
Now, how does RBI’s FCNR swap going to work? Currently, in the forward market banks are paying per annum 7 percent premium for the US dollars.But RBI promises 3.5 percent premium per annum for 3 years FCNR deposits. Thus overall cost of hedging is going to be reduced for Indian Banks. On the side note, this facility is only for US Dollar deposits.