By Vidya Ranganathan
SINGAPORE (Reuters) - Foreign banks are pushing to raise billions of dollars from expatriate Indians in response to New Delhi's drive to defend its weak currency, which could mean the government can avoid the need for a sovereign bond or state-backed deposit scheme to attract inflows.
The foreign banks are offering upfront financing for wealthy non-resident Indians (NRIs) of 90 percent to set up dollar deposits in India following various central bank incentives, including cheap dollar/rupee swap rates and more relaxed terms on 3-5 year dollar deposits, private banking sources told Reuters.
This would resurrect a practice which proved successful in drawing in dollars from non-resident Indians (NRIs) in 2000, when the rupee was also under pressure. In August, the rupee slumped to a record low close to 69 per dollar as investors fretted over a record current account deficit, hefty fiscal deficit and slowing growth, putting India high on the list of emerging markets vulnerable to any tapering of the U.S. monetary stimulus programme.
The banking sources said banks could raise $10 billion or more although Indian government officials said the New Delhi was confident the scheme could raise $15-20 billion. The sources declined to be identified because of the sensitivity of the issue.
"It's a disguised NRI bond because you are basically getting in money locked in for 3 years," said Rajeev Malik, senior economist at CLSA Singapore.
Indeed, Gaurav Kapur, senior economist at Royal Bank of Scotland in Mumbai, noted a sovereign bond would not have been ideal for a government that is running the risk of a rating downgrade from Standard & Poor's, which has a negative outlook on its debt.
In addition, the banking route averts the risk of public embarrassment should a sovereign bond offering not go well, said Gary Greenberg, head of emerging markets at Hermes Fund Managers in London.
"It looks very generous: desperate measures for desperate times," Greenberg said. "I suppose this is a little like war bonds. You do your patriotic duty, except that you are being richly rewarded."
Foreign banks, including Citi , DBS and Standard Chartered Bank < 2888.HK>, will officially launch the special bank accounts this week, offering their wealthiest private banking clients about 90 percent of the foreign currency deposit placed in India, the banking sources said.
"This will provide an opportunity to the foreign banks to leverage their balance sheets by lending up to 90 percent money to their NRI clients," a senior government official said.
The official said the idea of upfront loans was floated in July at a meeting between investment bankers and Raghuram Rajan, who was then with the finance ministry but is now central bank governor.
Although the official said the scheme was a "win-win situation", private bankers were more sceptical. NRIs would salivate at the returns but Indian banks would have to weigh up the costs, and the funds are expensive even after factoring in the central bank subsidy on swaps, they said.
By putting up just 10 percent "the client effectively makes between 18 and 21 percent on the dollars," a private banker with a European bank said.
But for the Indian banks, the effective cost of the rupee funds would be about 8.5-9 percent - even accounting for the cheap swap rate - limiting the investment options, the bankers said. Ten-year Indian government bonds yield about 8.5 percent.
The scheme is a variation of the foreign currency non-resident bank account (FCNR), which are term deposits non-resident Indians can maintain in several currencies, including U.S. dollars and euros, at banks onshore and earn a fixed rate of interest.
As part of efforts to rescue the sinking rupee, the Reserve Bank of India (RBI) freed interest rates on FCNR deposits last month.
It allowed banks to offer as much as 400 basis points over the London interbank offered rate (LIBOR) for deposits with maturities between 3 years and 5 years. It exempted these deposits from statutory bank reserves.
To incentivise banks, the RBI also offered to swap FCNR deposits of maturities above 3 years into rupees at a fixed rate of 3.5 percent, less than half the prevailing market levels. That swap window is available until November 30.
Banks, both foreign banks with a presence in India and local ones, have made a huge push to raise money from India's vast diaspora since the RBI relaxed rules on FCNR deposits. These deposits can be used as collateral to borrow overseas.
But under the upfront financing scheme, the banks pool their resources with non-residents and place deposits in India, thus creating bigger deposits with each new account.
CLSA's Malik is worried that the plan, while creative, was not prudent central banking. "You will get the dollar inflow, that's not the point," he said. "It's offering a selected subsidy on a swap and it's encouraging others to actually lever up."
One source at a European bank said some banks were offering clients insurance against the risk of capital controls being imposed on the deposits. Moreover, banks were cherry-picking clients for this product, he said.
"For every billion dollars I place in India, the bank has to fund $900 million," he said. "We can't allow just any customer to piggyback on us, only a handpicked few."
(Additional reporting by Manoj Kumar in New Delhi, Neha Dasgupta in Mumbai and Umesh Desai in Hong Kong: Editing by Neil Fullick)