FCNR flows to complicate liquidity management, lead RBI to deploy more tools: Economists

Mumbai: Higher-than-expected inflows through the FCNR(B) window will heighten liquidity issues and lead the Reserve Bank to deploy more tools to absorb the excess money, economists said on Thursday.

In comments that come a day after the RBI announced that banks have mopped up USD 127.23 billion of deposits from the diaspora at the close of the concessional swap facility, domestic rating agency Careedge said the new flows "complicate" the liquidity management for the central bank, especially with the banking system already saddled with excess liquidity at a four-year high.

Read more: Explained: What $127 billion FCNR(B) inflows mean for ICICI Bank, HDFC Bank, other bank stocks


Reminding that inflows from the separate swap facility for external commercial borrowings (ECBs) and overseas foreign currency borrowings (OFCBs), from which an additional USD 9 billion has come in, are open till December, economists said the central bank will have to deploy additional tools to absorb surplus liquidity in the banking system.

The dollar inflows translated into a sharp increase in domestic liquidity, with the system surplus touching Rs 9.71 lakh crore as of September 2, up from Rs 6.7 lakh crore at the end of August.

Barclays, in its report, said the liquidity surplus is substantially above the RBI's preferred level of around Rs 2.7 lakh crore and expects more liquidity absorption measures in the coming months.

Read more: Indian banks slash FCNR deposit rates by up to 310 basis points

The brokerage said it expects a mix of continued variable rate reverse repo (VRRR) operations and a possible incremental cash reserve ratio (ICRR) hike, but ruled out a permanent CRR increase without a sunset clause.

Bank of Baroda Research noted that FCNR(B) inflows surged by USD 62 billion in the last 10 days of the window alone, between August 21 and 31.

At the same time, some of the surplus is expected to drain naturally through higher currency demand during the festive season, possible forex intervention and forward maturities.

Bank of Baroda Research report said the RBI has already stepped up VRRR auctions, announcing operations cumulatively worth Rs 53.5 lakh crore between August 6 and September 2. Banks, however, have preferred shorter-duration operations amid robust credit demand.

Singaporean lender DBS' senior economist, Radhika Rao, said the large inflows had pushed system liquidity to a four-year high and that the RBI would have to balance the surplus against tax outflows, seasonal currency leakage, portfolio flows, the current account deficit and maturities in its forward book.

She said the central bank could consider temporary CRR measures, OMO (open market operations)/MSS (market stabilisation scheme) operations, forex sell-buy swaps, cash management bills and shorter-tenor VRRRs, among other options.

Rao also pointed to the RBI's record short forward position, which could create future dollar demand as these positions mature.

Emkay Lead Economist Madhavi Arora expects core banking liquidity to peak above Rs 10 lakh crore in September. She sees shorter-tenor FX sell-buy swaps, MSS and possibly ICRR (incremental CRR) as potential tools, while noting that around USD 32 billion of the RBI's forward book due in a year could mature and naturally ease the liquidity pressure.

Sneha Pandey, fund manager at Quantum AMC, favoured VRRR for daily fine-tuning and OMO sales for a more durable absorption of the surplus.

Pandey suggested OMO sales of around Rs 1-2 lakh crore in the two-to-five-year segment to limit pressure on the long end of the bond market, while viewing CRR and MSS as backup options.

Domestic brokerage Motilal Oswal's chief economist, Radhika Piplani, expects system liquidity surplus to rise towards Rs 11 lakh crore ahead of the festive season.

She said the liquidity impact would be strongest at the ultra-short end and expects further measures, with a policy rate hike more likely in December than October.

The large inflows have also strengthened India's external buffers. Foreign currency assets rose by USD 47.9 billion, taking forex reserves to a record USD 729.3 billion. However, the research house cautioned that the increase cannot be attributed one-for-one to the RBI's swap operations because of other dollar inflows and possible reserve intervention.

Barclays has consequently raised its FY27 balance-of-payments surplus forecast to USD 100 billion from USD 50 billion earlier, citing stronger-than-expected FCNR inflows and a lower projected current account deficit.