The Hindu : Forex kitty: Making sense of abundance

Online edition of India's National Newspaper
Tuesday, Jan 21, 2003

Business

Business - News Analysis

Forex kitty: Making sense of abundance

By Oommen A. Ninan

MUMBAI: While the interest arbitrage business is booming resulting in a surge in foreign exchange reserves, the Reserve Bank of India is looking at ways to utilise the swelling foreign exchange reserves, either repaying country's loans or supporting commercial banks to lend foreign exchange to corporates and exporters.

The RBI allowed foreign institutional investors last month to hedge 100 per cent of their exposure. This resulted in overseas banks parking their funds here through non-resident Indians in India by way of interest arbitrage. Assume the London Inter Bank Offered Rate (LIBOR) is at the current 1.40 per cent and 3.5 per cent is the forward cover cost totalling almost 5 per cent. Now, if an institution or an NRI gets a return of 7 per cent then they are netting an arbitrage of 2 per cent without bearing any risk.

"This led to the recent inflow of foreign exchange to the country," said Shyam Poddar, Managing Director of the Delhi-based Forex Capital Services. Moreover, exporters who were tempted to give their long credit in anticipation of rupee appreciation are also bringing their money in quicker in view of the steady rupee appreciation. This is further adding pressure on the reserves position. This large forex inflow prompted the RBI and the Central Government to announce a slew of measures liberalising norms for availing of foreign exchange. Similarly, the Government allowed individuals, companies and mutual funds to make equity investments in companies listed overseas.

There is a general perception that the Government should repay its foreign exchange debt while domestic exporters and industries are facing severe crunch for providing foreign currency loans due to paucity of FCNR (B) funds.

"In the present scenario, it would have been more appropriate if our central bank lends these funds for short term to the banks to give them a cushion while providing funds to the exporters and corporates," said Mr. Poddar.

In any case, the RBI gets a return out of its reserve, say 1.75 per cent to 2 per cent and by adding the ongoing premia of 3.5 per cent, this is still equivalent to the rupee repo rate which is 5.5 per cent. Furthermore, Mr. Poddar believes that the RBI will be in a position to check the money supply through the foreign exchange route.

Even though there is a general belief that there is crunch for foreign exchange in the market in spite of the healthy reserves, another school of thought believes differently. "There is no need for the RBI to lend foreign exchange to commercial banks," said Ashish Parthasarathy, Head, Trading, HDFC Bank. However, he said there was shortage of dollars in the market. Usually, banks take foreign currency deposits (like FCNR (B)) and use these funds for lending through foreign currency loans.

According to Mr. Parthasarathy, the role of the RBI is not to lend foreign currency to commercial banks so as to enable them to distribute it to corporates and exporters.

Another issue that worries the RBI is the $100 billion unhedged foreign exchange position. Assuming total exports of the country is $45 billion annually and an average cycle of the export realisation (including credit and transit period) is four months of the exports which works out to $15 billion (one third of the yearly turnover), imports are more than $50 billion and the six-month average turnover works out to $25 billion.

In addition, orders in the pipeline and other receivables and payables are estimated at $22-25 billion and external commercial borrowings (ECBs), apart from other long term credit, are around $30 billion. NRI deposits and other deposits constitute around $27 billion now. "If we sum up all these numbers, even at a most conservative estimation, the country's unhedged foreign exchange should be $80-100 billion. However, there is no foolproof mechanism for our regulator to assess the unhedged current account and capital account position of the country," said Mr. Poddar.

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