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"The capping of the interest rates also ensures a level playing field amongst players and prevents unhealthy competition.''

Mumbai , July 17

IN what is seen as an attempt to eliminate arbitrage opportunities, Reserve Bank of India today clamped a ceiling on the rate of interest on NRE deposits. This is expected to bridge the wide difference in interest rate being offered to NRI depositors in India and the prevailing rates overseas.

The central bank has imposed a maximum interest rate of 250 basis points (2.50 per cent) above the London Inter Bank Offer Rate/SWAP rates for corresponding maturity on Non-Resident External deposits. The new rates will be effective from July 17 and will be applicable to fresh deposits and deposits renewed after their present maturity.

The rates on Foreign Currency Non-Resident deposit, however, remains unchanged at 25 basis points minus LIBOR/SWAP of the corresponding maturity.

"The ceiling on deposit rate may put a stop to the leveraged flow of funds as genuine investors will now have a choice between 1.25-1.50 per cent abroad and 3.50-3.75 per cent in India on a one-year deposit. Only people who are bullish on the Indian rupee and who will risk running an open position without taking a forward cover will invest here,'' said Mr Moses Harding, Executive Vice-President, IndusInd Bank.

"This measure will bring down the excessive supplies of the dollar into the Indian market, thereby the RBI's daily absorption of dollar liquidity will come down and the accretion to the forex kitty too will slacken. However, the Indian rupee will continue to appreciate since all other positive factors regarding India remain unchanged,'' he added.

Meanwhile, the asset liability committees of various banks are meeting today to comply with the new stipulation and set the new rates.

NRE deposits will now see interest rates slashed by 1.00-2.00 percentage points. Taking London Inter Bank Offer Rates as on July 16 into consideration; the interest rate on the one-year deposit will be capped at 3.72 per cent, on two-year deposit at 4.13 per cent and the three-year at 4.68 per cent. For purpose of operational convenience, RBI has suggested that the interest rates could be rounded off to the nearest decimal point. At these rates, if an investor were to take a forward cover to hedge his foreign exchange exposure, there would be no difference between the returns earned be it invested either in India or abroad.

State Bank of India, the largest bank in the country, was offering 5 per cent on one-year, 5.25 per cent on two-year deposit and 5.50 per cent on the three-year deposit. These rates will now have to be revised following the new ceiling.

The maturity period of NRE deposits would continue to be one to three years and the interest rate as determined above for three year deposits would also be applicable in case the maturity period exceeds three years. A majority of NRE depositors prefer one-year deposit and hedge it with a forward cover. It is only the speculators who do not take the forward cover. These speculative investors might continue to invest punting on an appreciating rupee.

"The capping of the interest rates also ensures a level playing field amongst players and prevents unhealthy competition. Some banks were even offering as high as 7.0-7.50 per cent on the 3 year NRE deposit. Such efforts to lure depositors will no longer be possible,'' said an official in a public sector bank.

A recent RBI study stated that accretion to foreign exchange reserves' was not due to "arbitrage'' opportunities but due to other factors such as surplus in the current account, foreign investment and banking capital. The study said: "There has been a net increase of $2.8 billion in NRI deposits as compared with $2.4 billion during April-December 2002. In the previous year, 2001-02 also the main addition to NRI deposits was of the same order. Thus, there is no evidence of greater "arbitrage" having contributed to higher accretion to reserves in the fiscal year 2002-03.''

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