Puzzling policy: Premature ending of FCNR (B) swap raises questions
From the turn of events, it would appear that the scheme was not adequately thought through. India’s foreign-exchange reserves were at about $680 billion when the scheme was announced, and it was unlikely to face any difficulty in meeting immediate external obligations. However, the rupee was under pressure due to a variety of factors. The Iran war had pushed up the prices of crude oil, and most economists expected the current account deficit (CAD) to expand, though not to alarming levels. Pressure was also coming from the capital account because of persistent selling by foreign portfolio investors, partly because of global uncertainties. Thus, the swap schemes were interpreted as an attempt to further bolster foreign-exchange reserves to help stabilise the currency market. Sometimes sharp currency depreciation can become a self-fulfilling spiral. Higher reserves usually discourage speculators betting on sustained declines. But foreign-currency reserve accumulation also has costs.
Since the RBI has decided to close the scheme after getting a little over $50 billion, it is not clear what the expectations were. Analysts were expecting $80 billion-100 billion to come under various swap windows. Did the RBI not expect similar levels of flows? Banks were incentivised to raise deposits and were offering substantial leverage. It is not clear if the objectives have been met. Besides, what would have been the downside of accumulating more foreign-exchange reserves? A much higher reserve could have artificially pushed up the rupee exchange rate. Liquidity in the system would have significantly also gone up. But could the central bank not anticipate or manage such after-effects? Further, it was indicated in the last post-monetary policy press conference on August 5 that there was no proposal to close the scheme prematurely. What changed over the next nine days? Both the announcement of the scheme and its premature withdrawal indicate a lack of proper policy planning and do not augur well for a large central bank like the RBI.
At a broader macro level, as this newspaper has argued, irrespective of the fund mobilisation, the scheme will not solve the fundamental problem. India runs a CAD and needs foreign savings to push up investment. Foreign direct investment (FDI) is considered the most stable form of overseas capital. But the flow under this head has not been as desired over the past few years. Outward FDI by Indian firms and repatriation by foreign firms have affected the net balance, which is important for the balance of payments (BoP). After witnessing a BoP deficit over the past two years, the first quarter this financial year also remained in deficit with a gap of $8.1 billion. Net FDI was at $7.8 billion during the quarter. India certainly needs to do much better to keep the external account under control, which will also impart stability to the currency market. However, not much has happened over the past few months on bringing in stickier long-term capital.