RBI’s FCNR(B) swap mobilises $136 billion in 90 days; BofA sees Rs 40 lakh crore credit potential

The latest market report highlights that The Reserve Bank of India’s special FCNR(B) swap window has mobilised $136.4 billion in foreign-currency deposits in around 90 days, giving India a much larger balance-of-payments cushion but additionally creating the potential for a sizeable expansion in domestic liquidity and bank credit, according to BofA Securities.

BofA has boosted its forecast for India’s FY27 balance-of-payments surplus to $90 billion from $45 billion, equivalent to 2.2 percent of GDP, following the scale of inflows through the scheme. It anticipates the surplus to moderate to $50 billion, or 1.1 percent of GDP, in FY28 as capital flows normalise.

The immediate impact is on India’s external position. The RBI’s balance sheet has expanded by Rs 5.4 lakh crore since end-May, largely reflecting the accumulation of foreign assets. BofA anticipates the country’s foreign exchange reserves to cross $750 billion soon, followed by $775 billion in FY27 and $800 billion in FY28.

But the larger offering for the domestic economy is what happens to the liquidity created by the inflows.

BofA estimates that around Rs 12 lakh crore ($125 billion) of base money could enter the banking system. With a money multiplier of around four times, this could eventually backing Rs 30 lakh crore to Rs 45 lakh crore of broad-money creation. Of this, the brokerage estimates that Rs 25 lakh crore to Rs 40 lakh crore could translate into additional non-food bank credit.

That would be equivalent to around 7-11 percent of GROSS DOMESTIC PRODUCT and 11.5-18 percent of the existing non-food credit stock. BofA estimates the additional credit could lift GROSS DOMESTIC PRODUCT expansion by around 50-80 basis points.

The effect is likely to show up gradually rather than immediately, as banks need to deploy the additional liquidity and credit demand has to absorb it. But the scale of the potential credit expansion additionally creates a new set of macroeconomic risks.

Stronger credit expansion could propel up domestic demand and add 0.3-0.5 percentage points to core inflation over the medium term, BofA estimates. Elevated demand could additionally gain imports faster than exports, widening the current account deficit by around 0.3-0.5 percentage points of GDP.

The impact on banks, in the meantime, is likely to be more immediate. FCNR(B) deposits offer lenders a cheaper source of funding than domestic three-to-five-year deposits. Domestic term deposits have been boosted at around 6.5-7.5 percent, compared with 5.25-6 percent for FCNR(B) deposits under the current window. The deposits additionally receive exemption from CRR and SLR requirements.

Softer funding costs have already started feeding into wholesale borrowing rates. Twelve-month certificate of deposit rates have eased to around 6.75-7 percent, reducing some pressure on banks' funding costs.

BofA additionally argues that concerns over the RBI taking a loss on the swap may be overstated. The central bank's annual hedging cost is estimated at 2.8-3 percent, while the foreign reserves acquired through the operation can earn around 4-4.25 percent in short-duration US debt and around 4.5 percent at a five-year duration. This gives the RBI an estimated positive carry of roughly 100-170 basis points.

At the end of the swap period, the outcome will additionally depend on the indian rupee. BofA estimates the RBI could make an outright earnings if the indian rupee stays stronger than roughly Rs 105-110 per dollar in FY29-FY31.

The FCNR(B) programme is not without precedent. During the 2013 currency stress, FCNR(B) deposits rose from around $15 billion to $39.3 billion by November that year. By 2016, the stock had fallen to around $21 billion, implying that roughly a quarter of the inflows were retained permanently.

That history is relevant because the current inflow provides a temporary lift to India’s external funding position rather than removing its longer-term need for foreign capital. BofA estimates India will still need around $100 billion of net investment capital a year to finance its external requirements once the impact of the swap normalises.