Raghuram Rajan announced last week that banks can swap dollars raised through FCNR deposits for rupees at a fixed swap rate of 3.5%, much lower than the market rate of 7-8%. The RBI, in an earlier move had also liberalized interest rates on FCNR deposits from LIBOR + 300 bps to LIBOR + 400 bps. Analysts forecast that $10-15 billion dollars would flood in on account of these moves. That’s fantastic - it helps us bridge our current account gap and supports the tumbling rupee.
But does it also given an enormously unfair advantage to wealthy Non-Resident Indians on the returns they earn?
Reports suggest that foreign banks like Citi, DBS and Standard Chartered are providing 90% - 190% leverage to their clients, depending on risk profile and will be rolling out upfront loans this week. This basically means if a client wants to invest $100 in an FCNRB deposit, the bank is willing to deposit $900 to 1900 on the client’s behalf in an FCNR account enabling the client to earn interest on not just his $100, but also the bank’s loan. This effectively gives the NRI a return of between 20-40% on his investment as we will see.
This when Indians are earning a measly 8-9% on FDs!
Here's how it works –
Mr. NRI wants to invest $100 sitting in Singapore. As he is an ultra HNI client, XXX Bank agrees to loan him $1900 at a rate of 1-2% over LIBOR (works out to around 2.5%).
He takes this $2000 and parks it in an FCNR deposit which yields him an interest rate of about 4.5%. The NRI effectively makes 2% (4.5%-2.5%) on his leveraged component and the entire 4.5% on his own equity – i.e. – he makes $4.5 on his $100 and 38 dollars on the bank’s $1900 loan.
That’s a return of $42.5 on his $100 investment – i.e. 42.5%
Even if you assume that the leverage is $900 dollars – i.e 90%, you are stil getting a return of $4.5 + $18 – ie. $.22.5 on your $100 – that’s a 22.5% return.
One way of looking at this is – it is getting us the much needed dollars. But resident Indians would say while the wealthy NRI is laughing all the way to the bank, the Indian investor battling a prolonged bout of inflation & earning peanuts in real returns, with even his last guard against inflation – gold made costlier, is being left high & dry!