India may need to repay $130 billion of FCNR inflows in 3-5 years; long-term capital key: JPMorgan

India’s huge FCNR inflows have bought the country time, but the real challenge is to attract stable, long-term capital before those liabilities have to be repaid, according to Sajjid Chinoy, Head of Asia Economic Research at JPMorgan.Chinoy told CNBC-TV18 that around $130 billion could need to be repaid over the next three to five years. To meet those obligations, India will need to generate sizeable surpluses from its external transactions and, more importantly, bring back permanent capital flows such as foreign direct investment (FDI).“The real question is, what are we going to do… to attract more capital flows on a permanent basis? How do we get stable, patient, long-term capital into India? That’s the real challenge,” Chinoy said.The comments come after foreign currency inflows through the Reserve Bank of India’s special windows since June surged to around $136 billion, with an estimated $127 billion coming through FCNR(B) deposits. The size of the inflows has been far larger than most market participants had expected.Why FCNR inflows were so largeChinoy said the FCNR(B) scheme was attractive to non-resident Indians because it offered unusually high returns after taking the cost of protecting against currency movements into account.JPMorgan’s estimate, based on a conservative leverage ratio of 9:1, suggested fully hedged dollar returns of around 13-15%. If leverage increased to double-digit levels, the return could rise to around 20%, he said.“That was a very attractive proposition,” Chinoy said, adding that while the attractiveness of the scheme was clear, the sheer size of the inflows surprised the market.JPMorgan’s trading team had initially estimated that the inflows could be between $80 billion and $100 billion. The bank did not publish that estimate at the time because it did not want to encourage speculation.Repayment is not an immediate concernChinoy said there was little reason to worry about repayment at this stage because the liabilities will fall due over a period of three to five years.However, if India has to repay around $130 billion, it will need to generate foreign exchange surpluses of roughly $40 billion-$50 billion a year, he said.A decline in oil prices could help. If the Middle East conflict does not persist and oil prices ease, India’s current account deficit could return to around 0.5%-1% of GDP, according to Chinoy.But he said the bigger task is to make India a more attractive destination for long-term foreign investment.“If we can attract those FDI flows or make India a good proposition for capital to come to, then hopefully we will generate those surpluses and, you know, pay this back,” he said.The FCNR inflows, therefore, should be seen as a bridge rather than a permanent source of foreign currency.Large inflows create a liquidity problem for RBIWhile the inflows have strengthened India’s external position, they have also created a problem for the RBI: a large amount of rupee liquidity in the banking system.Chinoy estimates that core liquidity in the banking system is around ₹15 trillion, while headline liquidity is close to ₹12 trillion.Such a large surplus could push short-term interest rates well below the RBI’s policy rate. That would amount to a form of monetary easing at a time when the central bank is signalling a more cautious approach to interest rates.Chinoy said the RBI therefore needs to act relatively soon to prevent excess liquidity from weakening the impact of its interest-rate guidance.One option is a cash management bill, which would allow the government to temporarily absorb some of the excess money from the financial system. Another is to increase the cash reserve ratio (CRR), the portion of deposits banks are required to keep with the RBI.The CRR is currently 3%. Chinoy said the RBI could temporarily raise it to 4% for six months and then gradually bring it back to 3%.The central bank could also continue using variable rate reverse repo operations to absorb liquidity, although Chinoy doubts these alone would be enough to deal with an overhang of this size.RBI needs to encourage two-way movement in rupeeChinoy also said the RBI’s approach to the currency market will be important in preventing a repeat of the hedging behaviour that had contributed to pressure on the rupee earlier in the year.He argued that the central bank should allow market participants to see the possibility of the rupee moving in both directions, rather than assuming that the currency will only weaken.For instance, when oil prices fall or the dollar weakens, the RBI could signal that it is comfortable with a stronger rupee. That could encourage exporters to protect themselves against a rise in the rupee and bring more participants into the currency market.The objective, he said, should be to create a more balanced market while making use of the reserves and other tools now available to the RBI.The cost will ultimately be borne by the public sectorAlthough investors in FCNR(B) deposits face little direct sovereign risk, the cost of the arrangement ultimately falls on the public sector, Chinoy said.The RBI will have to return the dollars when the deposits mature. At the same time, the central bank may have to pay a higher interest rate to absorb the rupee liquidity than it earns by investing the corresponding dollars in US markets.That could reduce the dividend paid by the RBI to the government.Chinoy said this cost needs to be weighed against the macroeconomic stability provided by the inflows, particularly at a time when global monetary policy could become less supportive of emerging markets.He expects a more synchronised tightening cycle among developed-market central banks, with the US Federal Reserve and Bank of Japan under pressure to raise rates. Higher global interest rates could make it harder for emerging markets, including India, to attract foreign capital.“Therefore, the fact that we have all this ammunition, I think, will hold us in good stead in the coming months,” Chinoy said.7.8% GDP growth was not a surpriseChinoy also pushed back against the debate surrounding India’s 7.8% GDP growth in April-June, saying the high-frequency data had already pointed to a strong quarter.He highlighted strong growth in automobile sales, bank credit, corporate earnings and exports. JPMorgan’s own forecast was for 8% GDP growth and 8.2% GVA growth.The biggest surprise, he said, was the strength of exports. Net exports contributed around three percentage points to the 7.8% GDP growth rate.Chinoy also dismissed arguments that the headline growth number was mainly the result of changes in the statistical base or the way inflation is adjusted in the GDP calculation.India moved to a new 2022-23 base for its GDP series earlier this year. Chinoy said comparing figures under the new series with those from the older 2011-12 series can therefore give a misleading picture.“I think the whole debate is a little bit of a storm in a teacup,” he said.For him, the more important question is not whether the 7.8% number is credible, but how much of the current growth momentum can be sustained.Turning cyclical recovery into structural growthChinoy described the current phase as a cyclical recovery, helped by strong domestic activity, higher exports, a weaker real exchange rate and front-loaded public investment.Some of these factors are likely to fade as the year progresses. As a result, he expects full-year growth to be around 7% or slightly below 7%.The bigger challenge is to turn this temporary upswing into sustained growth driven by private investment and job creation.“It’s a cyclical pickup. What do we need to do to make the cyclical into structural? That’s the real debate,” Chinoy said.Watch accompanying video for full conversation.

Source link