Rupee denominated ECBs may be a non-starter!
RBI allows Indian entities to borrow in Rupees (instead of designated foreign currency) from approved foreign lenders. The intent of this relaxation ideally has to be to shift currency exchange rate risk from borrowers to lenders. In the current context, most (if not all) ECBs are kept unhedged in what is called the carry-trade funding to benefit from the huge interest rate differential between high cost Rupee funds and low cost foreign currency funds, denominated in either USD or Euro or GBP or JPY or Swiss Franc. In earlier days, given the market imperfections, FX premium (called the swap cost to convert the borrowed foreign currency into Rupees) was not reflective of the interest rate differential for various reasons from lumpy one-way demand - supply dynamics. It was then making sense to avail ECBs in foreign currency and make an arbitrage on fully hedged basis. The borrower was not concerned on the mark to market impact on the hedge from currency volatility (and the resultant credit risk impact from the market risk) during the door-to-door life of the hedge. The brave-heart borrowers chose to run the currency risk till maturity on assumption (and comfort) that annualised Rupee depreciation will be much lower than the interest cost differential enjoyed during the currency of the loan. The journey was not bad for ECB borrowers, while the pain was for short term (3-12 month) carry-trade borrowers on sudden downside value adjustment on the Rupee. Despite all these risks in play, Indian borrowers have the comfort to take exchange rate risk through unhedged ECB/FCNR(B) loans, short term usance import letter of credit or synthetic FX Currency swap transactions. Then, what is the need for Rupee ECBs?
RBI strictures on the overseas Rupee lender to undertake door-to-door hedge with an Indian authorised dealer for Rupee disbursements and repayments on a fully hedged basis is clog on the wheel. Indian swap markets have turned efficient in capturing near perfect interest rate differential, thereby cutting cost advantage on fully hedged cross-border loans or investments. This means that on a fully hedged basis, Indian borrower is better off to avail Rupee loans in domestic market, while off-shore lender has no monetary incentive to lend in Rupees instead of USD. It does not make sense for the off-shore lender to set up credit lines with Indian Banks against periodical mark-to-market settlement on the open forward leg of the swap.
All combined, while Indian borrowers (who operate on fully hedged basis) will be happy to welcome Rupee denominated ECB (to avoid hedge deals with domestic banks), off-shore lenders will see no sense to take on the operational risk on their books without significant yield advantage. It would make sense for RBI not to make it mandatory for off-shore lender to cover the underlying Rupee loan exposure against the home currency. All taken, while demand for Rupee ECB will be from entities who operate on fully hedged basis, supply appetite may not exist. Just thinking aloud to make it work!
Gold deposit scheme is step in the right direction to avoid use of domestic capital to fund bullion imports
India Gold bullion imports is conversion of financial liability to non-financial assets. While bullion imports are funded by Rupee system liquidity, conversion of bullion to jewellery get into idle mode in safe deposit lockers, adjusting for loan against gold jewellery. The recent scheme of Gold jewellery deposit scheme is firm step in the right direction with the twin objective to reduce pressure on the CAD and retain domestic capital for put to domestic use within India rather than shipping it out.
How the scheme will work to achieve desired results? Banks are allowed to accept Gold Bullion/jewellery deposits from resident entities against payment of interest. It is also said that Banks will extend Gold Metal loans to jewellery manufacturing units at a spread over the interest paid to depositors. It is not as simple it looks. The manufacturer will need bullion bars, which have to be shipped in from overseas suppliers. Ideally, only the nominated banks authorised to import Gold will become eligible to accept Gold deposits. Banks instead of making payment at sight (or with usance) to the supplier will issue perpetual revolving letter of credit not exceeding the value of Gold deposits held (with 10-25% hair cut) in favour of the suppliers. Such SBLCs can be discounted by the overseas supplier in the off-shore market. On due date of payment, discount of the fresh LCs will kick-in for payment to the discounting bank. This cycle will be perpetual in nature to avoid conversion of Rupees into USD for import of bullion till the system get into Current Account Surplus mode, when foreign capital can be used to fund Gold imports. It is a very good move and the beneficial impact is to be seen from how it gets implemented.
Neutral impact on Rupee exchange rate
Combination of these two measures will cut ECB $ supplies and remove Gold $ demand. The beneficial impact is also from retaining domestic liquidity for domestic uses. RBI strategic agenda to turn surplus on Current Account and preserve domestic capital against unproductive use are steps in the right direction. RBI follow-up actions to ensure speedy implementation by removing hurdles on the way ahead is critical.
Moses Harding
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