RBI’s FCNR Reversal Puts Its Guidance Under Scrutiny

Among the many memorable observations made by former Reserve Bank of India Governor Y.V. Reddy, few have aged as well as his quip: “Everywhere around the world, the future is uncertain; in India, even the past is uncertain.”

It was classic Reddy, witty, understated, and layered with meaning. The RBI’s decision to close the special FCNR(B) deposit swap window ahead of schedule gives the remark fresh relevance.

To be clear, the issue is not the decision itself. Central banks must respond to evolving circumstances. If the facility attracted larger inflows than anticipated, there may well have been a case for revisiting its duration. The issue is how expectations were shaped and then altered within a remarkably short period.

Banks act on official guidance, committing resources and balance-sheet capacity to the opportunities it creates. Changing that guidance therefore carries a cost.

On August 5, RBI Governor Sanjay Malhotra said there was “no proposal under consideration” to close the scheme prematurely. He also said the RBI had no mobilisation target and expected healthy inflows to continue. Nine days later, the central bank announced that the swap window would close on August 31, a month earlier than originally envisaged.

The RBI was entitled to change course. But after an apparently categorical assurance from the governor, it needed to explain what had changed.

Policy Rationale
The FCNR(B) facility was not a routine deposit mobilisation exercise. Banks had to market it offshore, engage with non-resident customers, arrange funding and complete documentation. Many may have committed resources on the understanding that the window would remain open until September 30.

The RBI said the decision reflected the “encouraging response” to the facility and the resulting foreign exchange inflows. By August 13, banks had raised $52.3 billion through FCNR(B) deposits eligible for the swap. That is a substantial mobilisation and may well have met the central bank’s objective.

There are plausible reasons for drawing the facility to a close. Additional inflows may have offered diminishing benefits, future swap obligations may have become less attractive, or the RBI may have judged that the external position had been sufficiently fortified.

What is missing is not a possible rationale, but an articulated one. “Encouraging response” explains why the RBI was satisfied with the outcome. It does not explain why a facility with no stated mobilisation target, and which the governor said would not be closed prematurely, had to be curtailed nine days later.

That gap has shifted attention from the merits of the decision to the reliability of the communication preceding it. The RBI may have achieved the scheme’s economic objective while creating avoidable uncertainty about its own guidance.

Communication Burden
Central banks shape the expectations through which policy affects financial behaviour. That gives considerable weight to every public statement made by a central-bank governor.

There was a time when opacity was treated as an institutional virtue. That world has largely passed. Modern central banking works substantially through communication. Decisions influence markets not only through what they do today, but also through what they signal about tomorrow.

Alan Greenspan’s reference to “irrational exuberance”, Mario Draghi’s “whatever it takes” pledge and Ben Bernanke’s comments on reducing bond purchases all demonstrated how official words can move markets before policy action is complete.

The FCNR(B) episode is plainly not of the same scale. The relevant point is narrower: banks can take commercial and balance-sheet decisions on the strength of a governor’s statement. Communication is therefore part of policy transmission, not commentary standing apart from it.

This does not require a central bank to bind itself regardless of circumstances. No responsible policymaker can guarantee that today’s position will remain unchanged tomorrow. Exchange rates move unexpectedly, capital flows reverse and geopolitical events alter assumptions.

There is a difference between saying, “There is no proposal under consideration to close the scheme prematurely,” and saying that no such proposal is under consideration at present, while retaining the flexibility to review the window if inflows or external conditions change materially.

The first formulation sounds definitive. The second preserves policy flexibility and tells market participants what could alter the position.

What markets seek is not certainty of outcomes but consistency of framework. A credible central bank is not one that never changes its mind. It is one that explains why it changed its mind, particularly when regulated institutions have acted on its earlier words.

The debate should therefore not be reduced to whether the RBI was right or wrong to close the window early. The decision may prove entirely justified. The more important institutional question is why the central bank did not explain the change against the assurance given only days earlier.

Reddy’s observation was made in a different context, but its warning travels well. Policymaking will always involve uncertainty. The challenge for a central bank is to ensure that when the future changes, the public does not feel that the past has been rewritten.