Towards stable forex inflows

TWO RECENT DECISIONS of the Reserve Bank of India concerning non-resident Indian investment have implications for the external sector as a whole. The first of those is to make banks lower the interest rates on NRI deposits. The new ceiling, one percentage point over the London Interbank Offered Rate or Libor, is sharply lower than what was fixed as recently as in June, 2.5 percentage points over Libor. The second RBI directive bans Overseas Corporate Bodies from investing in India, including the various NRI bank schemes. In November 2001, following widespread allegations of OCBs manipulating in the stock market — later corroborated by a Joint Parliamentary Committee report — they were prohibited from investing in the secondary market through the portfolio management route. OCBs, owned directly or indirectly to the extent of at least 60 per cent by NRIs, include overseas companies, partnership firms, trusts, societies and other corporate bodies. The RBI move, though belated, is welcome. The OCB route specially created under the now defunct Foreign Exchange Regulation Act to facilitate NRI inflows into the country achieved its purpose but became a conduit for many unsavoury practices, including money laundering by resident Indians. To allay any apprehension in the minds of genuine investors, the RBI has since clarified that while the special concessions given to the OCBs have been done away with, they will rank on a par with other overseas bodies investing in India under various schemes.

The immediate consequence of the two directives might be a reduction in the quantity of foreign inward remittances. That in turn should affect not just the growth in bank deposits but also share prices in the stock market. The timing of the two directives has obviously to do with the healthy state of the external sector: remittances have made an important contribution to the accumulating reserves, now over $87 billion. The implication is clear: the country can do with more genuine and stable inflows than has been the case so far. At the reduced deposit rates that banks will now be offering, NRIs will hardly have any incentive to indulge in "arbitrage", borrow money available cheap in their country and deposit it at the higher yields offered by banks in India. The danger to the Indian banking system from such deposits is that not being genuine savings, they are susceptible to any number of extraneous factors, notably political turmoil elsewhere. As was proved once before in 1991, NRI money cannot be considered stable. The perils were even greater in the case of remittances coming in through the OCB route, which also made a mockery of exchange control regulations.

The issue of reining in certain types of foreign inward remittances assumes a certain topicality now — as the time to redeem the $5.3 billion Resurgent India Bonds draws near. Five years ago, NRIs and the OCBs patronised them abundantly; the high interest rates and the promise of repatriation in foreign currency acted like a magnet. For the country however, the RIBs have not been an unmixed blessing. They have been a very expensive form of deposit mobilisation. On purely yield considerations, the RIB holders might shift their maturing deposits to outside the country. The central bank's recent directives dampen the hopes of those banks pitching for the money. Less clear at this stage is their impact on the rupee's exchange rate and buoyancy in the share market. While these uncertainties remain, given the past record of unsavoury practices the RBI has done the right thing by plugging the loopholes.

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