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Since 1st March, 1999
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Move to check dollar inflow, rupee rise

Mumbai, April 17: In a move that ran along expected lines given the sharp rise in the country’s foreign exchange reserves, the Reserve Bank (RBI) today ruled that interest rates on non-resident (external) rupee (NRE) term deposits for one to three years should not exceed the London Inter-Bank Offered Rate (Libor). The interest rate on NRE savings deposits has also been linked to the Libor/swap rates.

While some observers expect the move to curb such dollar inflows and also stem the rise of the rupee, the move came just hours after the central bank announced that the country’s foreign exchange reserves rose by a whopping $3.37 billion — one of its highest weekly gains — to $116.06 billion for the week ended April 9.

The measure has been taken after a review of the existing NRI deposit schemes, the RBI said in a statement issued today.

According to the statement, interest rates on NRE deposits for one to three years, contracted effective close of business on April 17, 2004, should not exceed the Libor/swap rates for the dollar of corresponding maturity.

The RBI added that this interest rate would be applicable in case the maturity period exceeds three years. Moreover, the changes in interest rates will also be applicable to NRE deposits renewed after their present maturity period.

While the interest rates on NRE deposits were linked to Libor/swap rates for the dollar from July 17, 2003, the RBI has been consistently working to curb the arbitrarge since last year.

The interest rates on these deposits were reduced from 250 basis points above the Libor on July 17 last year to 100 basis points on September 15, and later to 25 basis points on October 18.

The RBI has also linked the interest rate on NRE savings deposits to Libor/swap rates.

“The interest rates on NRE savings deposits should not exceed the Libor/swap rates for six-month maturity on dollar deposits. The interest rate on NRE savings deposits may be fixed quarterly on the basis of the Libor/swap rate of the dollar on the last working day of the preceding quarter. For the quarter April-June 2004, the dollar Libor/swap rate as on the last working day of March 2004 would be applicable,” it added.

At present, the interest rate on NRE savings deposits is linked to domestic savings deposit rate.

The RBI here clarified that since the account holder can withdraw savings deposits at any time, banks should not mark any type of lien, direct or indirect, against these deposits.

Though a few analysts project that the RBI move would further curb arbitration thus reining the rupee, there are others who disagree.

Speaking to The Telegraph, Sharukh Wadia, senior vice-president (treasury), IndusInd Bank, said that while huge inflows are coming in, the central bank has been finding it difficult to control them.

He added that despite today’s measures, the central bank will find it difficult to control these inflows since the interest rate differential is widespread between two currencies. While the US interest rates are currently at 1 per cent, there is a differential of 3.5 per cent.

Wadia said that given such a differential, the central bank could go in for a cut in repo rate when it announces the credit policy next month. The repo rate is now pegged at 4.5 per cent.

The RBI had recently divulged that during April-December 2003, NRIs had pumped in close to $3.5 billion.

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