India's Diaspora Fundraising Drive Expected to Cost Reserve Bank Billions

India’s record-breaking diaspora fundraising drive may prove costly for the country’s central bank, leaving it with a potential $10.6 billion price tag, according to economists.

The Reserve Bank of India’s (RBI) special deposit program drew far more money than expected, with inflows set to rise further once overseas foreign currency debt and external commercial borrowings are included, economists say.

“Market focus has now shifted to the consequences of these inflows for RBI’s liquidity stance and operations,” said A. Prasanna, an economist with ICICI Securities Primary Dealership, referring to the haul as ‘a problem of plenty.’

The inflows, through the special window that was offered in June to shield the rupee from sliding after hitting record lows, come at a cost for the RBI.

Under the foreign currency non-resident (bank), or FCNR(B), program, the central bank agreed to shield banks from losses if the rupee weakens, through a favourable currency-swap facility estimated to cost 3-3.5% a year. It will also need to absorb some of the extra cash pumped into the banking system as banks exchange the dollars they raised for rupees.

The two operations could cost as much as Rs.1.2 lakh crore ($12.7 billion) over five years, according to an analysis by Madhavi Arora, economist with Emkay Global Financial Services.

The RBI did not immediately reply to an email sent seeking details on the cost.

For now, the RBI doesn’t see the cost as a major concern because the final bill will depend partly on how the dollar proceeds are invested, according to a person familiar with the RBI’s thinking.

Repayment is unlikely to pose a major problem as India’s foreign-exchange reserves are expected to rise over the years from about $730 billion now and provide enough buffer to cover the amount raised. The person asked not to be identified because the matter isn’t public.

One risk is the potential impact on the RBI’s dividend to the government. The central bank transferred a record 2.87 trillion rupees in May, compared with 2.69 trillion rupees a year earlier.

Any reduction in the dividend could make it harder for the government to meet its budget targets.

“The funds raised, therefore, need to be deployed judiciously and productively to mitigate these first-order and second order fiscal costs,” Emkay Global’s Arora said.

The RBI could offset some of those costs by investing the dollars abroad. If the money is invested in 10-year US Treasuries yielding about 4.7%, the RBI could earn more in interest than it spends on hedging.

“On a net basis, per year cost could be as low as 100 billion rupees, or even marginally positive for the RBI,” said Gaura Sengupta, economist at IDFC First Bank.