Rupee loans to NRIs may attract foreign currency flows   Sep 05, 2012

The Indian economy has been reeling under pressure, as global economic environment has been downbeat and domestic factors too aren't in good health. Factors such as a high interest rate scenario, widening current account deficit, high fiscal deficit, unpredictable tax policies and sticky inflation are all showing a bearing on the Indian economy; and to worsen the situation there's political turmoil as well.

A combination of all these global as well as domestic factors have pulled the country's economic growth down from the 8% - 9% range to now 5.5% for the first quarter of 2012-13. Moreover, the Indian rupee is depicting signs of weakness, which is disturbing policy makers and several industries. Just recently, the Government addressed to this weakness in the Indian rupee by deferring GAAR by three years, as it expected that with this move it could hit two birds in one shot, i.e. make the investment climate conducive as well as attract foreign flows, which in turn could aid in containing the weakness for the Indian rupee.

In another move to provide some respite to the weak Indian rupee and boost capital inflows, the Finance Ministry has now proposed to raise the limit of borrowing rupee loans for Non-Resident Indians (NRIs) from their Foreign Currency Non-Resident (FCNR) deposits or FCNR (B) (bank accounts).

Such incentives, in the view of the Finance Ministry would help attract more foreign capital flows in the country which in turn will help bring down the CAD which touched 4.2% of GDP in 2011-12 Also, the high interest rate offered on FNCR deposits by India as compared to other countries may further entice the NRIs to put their foreign deposits in their FNCR (B) accounts in India.

At present, NRIs can take a maximum loan of Rs 1 crore against their FCNR (B) deposit which have seen a net outflow in recent months despite being popular non-taxable deposits. In the April-June 2012 quarter there was a net outflow of $696 million from FCNR (B) deposits against an inflow of $545 billion in the same quarter a year ago despite central bank taking efforts to encourage flows. Even banks are free to fix interest rates on these deposits within the limit set by the RBI, but couldn't stop the foreign capital outflow.

The Finance Ministry is also of the view that the higher loan limit will make these deposits more attractive to NRIs, as they will be able to use such borrowed funds for investments while their deposits earn an interest not available to them in their home countries. However, the Reserve Bank of India has some reservations about the proposals. The RBI is of the view that such money will flow specially into sensitive sectors which may create artificial sectoral bubbles and as such Government should look at other avenues rather than doing away with the limit. The Finance Ministry's proposal can be implemented only after consultation with the RBI.

We are of the view that, the initiative by the Finance Ministry may help prop up the FNCR (B) deposits to a certain extent, as once the rupee starts appreciating the rupee loans to NRIs may not remain attractive. This in turn may help to reduce the CAD to a certain extent. However, to have a sizeable impact on the CAD, the Finance Ministry should undertake measures to reduce imports of the country. Also, the Finance Ministry must take bold steps and undertake the reform process on a fast track in order to attract more foreign capital flows that too of stable nature. Moreover, steps to curb the depreciating rupee against the dollar should be undertaken by the RBI in order to reduce the impact of imported inflation.

High inflation and low to medium growth has been hurting the India Inc. for quite some time now. The capex plans of various companies have gone haywire due to high cost of borrowing. Even the retail consumers are feeling the pinch of servicing their EMIs due to high interest rates. The country needs both the Finance Ministry and the central bank to work together and bring India out of this vicious circle of high inflation and low growth.

And amidst this gloomy scenario, for those NRIs, who decide to borrow such funds for investment in various assets, it is imperative for such investors to keep a tab on their asset allocation in order to minimize their losses. To know about your ideal asset allocation, watch out for PersonalFN's Free to attend WebSummit on 'An Ideal Asset Allocation in Current Market Conditions' by Mr Ajit Dayal.

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