Context: The Reserve Bank of India (RBI) introduced a special swap facility to encourage Foreign Currency Non-Resident (Bank) [FCNR(B)] deposits and strengthen India’s foreign-exchange reserves amid rupee pressure.
FCNR(B) deposits: Foreign-currency-denominated term deposits maintained in India by Non-Resident Indians (NRIs); principal and interest are payable in foreign currency.
Currency risk: Under the special RBI swap, the RBI bears the foreign-exchange risk on the principal, while banks remain exposed to currency risk on dollar-denominated interest payments.
RBI swap facility: RBI provides banks foreign-exchange protection against rupee-dollar movements, enabling banks to mobilise foreign-currency deposits without bearing the principal's currency risk.
Reserve impact: FCNR(B) mobilisation brings foreign currency into India, thereby augmenting foreign-exchange reserves.
Unhedged interest exposure: If banks do not hedge future dollar-interest obligations, a rupee depreciation increases their rupee cost of purchasing dollars.
Possible macroeconomic effect: Simultaneous dollar purchases by banks to meet interest obligations could increase dollar demand and pressure the rupee.
FCNR(B) vs NRE: FCNR(B) deposits are maintained in foreign currency, whereas Non-Resident External (NRE) accounts are maintained in Indian rupees; FCNR(B) deposits therefore protect the depositor from rupee depreciation.
