Chapter 6

Non-Resident Indian Deposits in India: Trend and

Determinants

6.1: Introduction

One of the major components of India’s foreign capital is Non-Resident Indian (NRI)
deposits. Though the share of NRI deposits is becoming less important in the overall
external capital account of the balance of payments, this is by no means insignificant.
Even today, for acquiring foreign exchange, India heavily relies on the inflow of NRI
deposits. Also, in the external liabilities of the banks, the share of NRI deposits is the
highest. The total amount of NRI deposits increased from US$ 1050 million in March
1980 to US$ 33 billion at end-March 2004. In the year 2002-03, NRI deposits
accounted for 27.5 per cent of total net capital inflows in India. As the revised estimate
shows, at end-March 2005, NRI deposits having maturity period of more than one year
constitute about 26.5 per cent of total outstanding external debt of India.
India’s recourse to foreign capital in the form of NRI deposits was in line with the
practice followed by some other developing countries. A number of developing
countries mobilise a part of their external capital requirements through special deposit
schemes designed for non-residents. These schemes have been especially popular and
successful in countries with large expatriate population such as Turkey, Israel, Egypt,
Lebanon, Greece, Spain, Pakistan, Sri Lanka, Thailand and some East European
countries, e.g., Czech republic. Most of these countries have instituted deposit schemes
denominated in foreign currency as well as in their local currency. In most of the cases,
the principal of the deposit along with the accrued interest are freely repatriable without
an exchange rate guarantee provided by the central bank.
In the regime of almost closed capital account, NRI deposit schemes were
introduced in India mainly to finance the current account deficits. As a result, the
Government kept changing the policies towards these deposits as and when required
according to the need of external finance. Depending on how large was the deficit in

123
the current account of the balance of payments or how much was the need for acquiring
foreign exchange, government gave encouragement or discouragement to these deposits
by way of its policy announcements. Not only that, several times new schemes were
created while some of the existing ones were discontinued. Incentives also came in the
form of higher interest rates on these deposits. A detailed look into the changes on these
matters as well as on data will help us to analyse the need for these changes.
The structure of the rest of this chapter is as follows. In the next section, i.e., in
section 6.2, we have briefly discussed the definition of a NRI eligible to open such
deposit accounts, the schemes and benefits available to a NRI and the other available
alternatives to the NRIs to invest in India. In section 6.3, we have carried out a detailed
study on the trends of such flows and the nature of these flows has been discussed in
section 6.4. In section 6.5, we have discussed briefly important changes in the policies
towards NRI deposits over time. In section 6.6, we have carried out an empirical
exercise to find out the determinants of such flows in the post-Asian crisis period. The
final section, i.e., section 6.7 gives a summary and concludes.

6.2: NRI Deposits: Definition, Types and Benefits available to the investors

6.2.1: Definition of an NRI

Any Indian citizen who is currently staying outside India for an indefinite period for the
purpose of business, employment or vocation, or education (for education purpose one
should stay outside for at least 182 days in the preceding year for being treated as NRI)
or any such circumstance is treated as a non-resident Indian. People going for tourism,
medical treatment or business visit will not, under any circumstances, be treated as
NRIs.
Besides NRIs, Persons of Indian Origin (PIOs) can also avail the same services. A
person is a PIO if any or both of his/her parents/grandparents at any time were a
permanent citizen(s) of the undivided India. Even if one is of non-Indian origin or
parentage, and is married to a PIO, or to a NRI or to an Indian citizen, he/she is treated
as a PIO and can avail all the facilities available to NRIs.

124
6.2.2: Types of NRI deposit accounts

At present there are two NRI term deposit schemes. One is Foreign Currency Non
Resident Bank Account FCNR(B) and the other is Non Resident External (NRE) Rupee
Account.

Characteristics of FCNR(B) Deposit scheme

This is a foreign currency deposit scheme that can be kept in four foreign currencies,
namely, US Dollar, Pound Sterling, Euro and Japanese Yen. Money can be remitted in
any convertible currency. The concerned bank is supposed to convert it in any of the
above four currencies according to the depositor’s choice. Even NRIs can tender
foreign currency notes or travelers’ cheques. This deposit can be jointly opened with
other NRI(s) and both principal and interest are fully repatriable. The deposit is
exempted from Indian Wealth tax and the interest is exempted from Indian Income tax.
Also, premature withdrawal of fixed deposits are allowed but subject to an interest rate
penalty. Power of attorney for these deposits is permitted for local disbursements only.
Rupee or foreign currency loans are offered against the security of FCNR(B) deposits
in both authorized branches in India or overseas. However, overseas loans are subjected
to rules, if any, applicable in that country.

Rupee Deposits
At present, there are two rupee-denominated deposits. One is Non Resident (External)
Rupee Account (NRE), and the second one is Non Resident (Ordinary) Rupee Account
(NRO).

Characteristics of NRE deposit schemes

In case of NRE deposits, overseas savings of NRIs are remitted to India in any
convertible currency and after converting in Indian rupee these are placed in deposits.
For these deposits savings bank account, current account, recurring deposits and fixed
deposits can be opened. Both the principal and interest are fully repatriable and the
balance on this account is not taxable. For this deposit the cases for holding of joint
account, power of attorney and nomination facility are the same as that of FCNR(B).

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Characteristics of NRO account
These accounts may be opened with the local money earned as rent, dividend etc and/or
with the sale proceeds of property, inheritance etc. The account holders can also deposit
money earned outside. These may be current, savings or fixed deposit accounts and can
be jointly held by resident relatives for convenience of operation. Although the
deposited amount is for local use, certain specific repatriation benefits are allowed even
in these accounts.

6.2.3: Existing provisions for NRIs to lend and borrow using these deposits

NRIs have been permitted to borrow in India for the following purposes:

 Against bank deposits for local/personal needs. The Smart

International Account is a very convenient way to borrow on the
deposits held in India.
 Against shares and other forms of financial securities for local needs.

These borrowings will have to be repaid out of inward remittances or balances in

NRO/NRE/FCNR accounts. If the borrowed funds are to be used overseas, they can
arrange to borrow overseas using their repatriable bank deposits - NRE or FCNR - as
security. They can also lend to residents as long as the loan is not used for dealing in
real estate. Repayment of such loans is not repatriable and is required to be credited
into the NRO account.

6.2.4: Alternative investment routes available to NRIs

NRI deposits are not the only available opportunity for the NRIs to send their savings
back in India. Other alternative opportunities are the following:
 They can also remit money directly through remittances (shown in the
current account of balance of payments as current transfers).
 They can acquire shares of Indian companies directly (shown as FDI in the
capital account of the balance of payments). Such acquisition of shares by
NRIs towards making FDI in India, except in financial services sector, by
private arrangement no longer requires Government approval. They are also

126
 permitted to enter into forward sale contracts with ADs in India to hedge the
currency risk arising out of their proposed FDI in India. FDI by NRIs,
however, is negligible.
 They can make portfolio investments (in both equity and debt securities)
such as investments in shares, debentures, government securities, rupee
mutual funds etc. NRIs are permitted to purchase/sell shares and/or
convertible debentures of an Indian company through a registered broker on
a recognised stock exchange provided his/her transactions are routed
through designated branch of an AD in India subject to prescribed limits.
They are allowed to invest in exchange traded derivative contracts approved
by the SEBI out of rupee funds held in India on a non-repatriable basis.
However, data separately for NRI portfolio investments are not available).
 Another alternative is to invest in immovable properties.
These alternative investments may act as substitutes for the NRI deposits. On the
other hand, liberalization of the policies towards FDI and FPI by NRIs may also
augment NRI deposit flows as a result of increasing confidence of NRIs on the
economy. In this section we have tried to examine what exactly are the relations
between all these alternative routes of NRI investments. Chart 6.1 below shows the
trends in total net NRI deposits, private transfers from other countries and net
acquisition of shares by NRIs.

Chart 6.1: NRI Deposits and other alternative channels for

Investment in India by NRIs
8000
7000
6000
Value in US $ million

5000
4000 Transfers
3000
2000 NRI
Deposits
1000
Acquisition
0 of shares
1999-2000
1998-99

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

-1000 FII
-2000

Year

Source of data used: Handbook of Statistics, 2006, Reserve Bank of India

127
 A quick look into chart 6.1 above reveals that since 1998-99, there is no clear rising
or declining trend of NRI deposits. Acquisition of shares by NRIs does not show any
rising tendency, whereas private transfers have a clear rising trend. FIIs also show
rising trend in the past three years. However, this FII series is net investment by both
the NRIs and FIIs and does not tell anything about portfolio investment by NRIs only.
The correlation between monthly net inflows of total NRI deposits and acquisition
of shares by NRIs is 0.18722. The correlation being so small we can infer that there does
not exist any significant relationship between these two components. This means that
the motives behind investing in India through the direct investment route and those
behind keeping money in India in fixed deposits are different. Another reason may be
the fact that NRIs sending money to India through these different routes are different
sets of people. This is possible in view of the fact that individual investments in those
two components are very much different in amount as well as nature as acquisition of
shares means a lot of investible resource with the single investor whereas those keeping
fixed deposits are required to send far lower amount. However, the positive correlation
may imply that more and more acquisition of shares by some NRIs increases
confidence of NRIs as a whole and gives an encouragement to invest money in India in
fixed deposits also.
The correlation between NRI deposits and total FII inflows is much higher with the
coefficient being 0.296. NRIs keeping fixed deposits in India feel encouraged when
confidence of the rest of the world on India increases or the investment environment of
India improves. However without having detailed knowledge about the investment
patterns of NRIs, it is difficult to reach to any conclusion.
The correlation coefficient between net NRI deposits and private transfers is
0.21823. This implies that NRIs do not see deposits as a substitute for transfers. They
have a separate motive behind keeping interest-earning deposits in India.
The preference of NRIs over alternative investment opportunities depends to some
extent on the country where they reside now24. Whereas NRIs from the Middle East
(large unskilled labour class) have a strong affinity to India given local constraints and
thus send considerable amount as transfers, those in the Asia-Pacific (largely Hong-
Kong and Singapore) prefer other alternative investment options such as

22
Data range from April 1998 to March 2006.
23
Data range from quarter 1 of 1998-99 to quarter 4 of 2005-06.
24
See Kaul (2000)

128
equities/mutual funds/currency/margin products. NRIs in Europe and Africa are very
conservative about savings. The largest NRI market is the United States where NRIs
have a very large stock market options. They have also high demand for property in
India and money transfer.

6.3: Trends in inflows under NRI Deposit schemes

NRI deposits were introduced essentially to increase the flow of foreign exchanges in
India under the circumstances that except for one or two years, current account was
showing huge and increasing deficits every year. As the government gave special
incentives to the NRI deposits, this relatively high-cost as well as short maturity
sources of external finance increased significantly to supplement external assistance as
a source of external finance.
At the beginning, NRI deposit schemes were introduced with only a rupee-
denominated deposit, the Non-Resident (External) Rupee Account (NRE), with
repatriable principal and interest. In November 1975, a foreign-currency denominated
deposit scheme, the Foreign Currency Non-Resident Account [FCNR(A)] was added.
This deposit was also repatriable. RBI gave encouragement to banks by assuming itself
the exchange rate risk. However, till 1980s, these two schemes could attract only a
meager amount of US$ 850 million on account of NRE deposits and US$ 200 million
on account of FCNR(A) by March 1980.
In the 1980s, in response to a lot of special incentives given to these deposit
schemes, NRI deposits started gaining momentum. At that time, nearly half of the non-
concessional debt was coming from NRI deposits. By March 1990, outstanding amount
of NRI deposits increased to US$ 12.4 billion. Huge inflows on account of FCNR(A)
led to an increase in the share of FCNR(A) to 70% of total NRI deposits. The
preference of depositors towards foreign-currency denominated deposits over rupee
denominated ones was perhaps due to the higher rates of interest offered on FCNR(A).
Also the absence of exchange rate risk on these deposits encouraged banks to pull
higher amount on this account.
During the balance of payments crisis, in the early 1990s NRI deposits showed a
high degree of volatility irrespective of maturity constraints. The system of easy

129
repatriability of deposits made them vulnerable in the event of a crisis. At the time of
external payment difficulties of 1990-91, there were huge outflows of NRI deposits,
even prematurely with the loss of interest. Outstanding amount of total deposits
declined by US$ 904 million during 1991-92. In the case of FCNR(A) deposits, in
contrast to an average annual inflow of more than US$ 1.3 billion (excluding accrued
interest) during the three-year period 1987-88 to 1989-90, the inflow declined to a
trickle (a mere US$ 168 million) in 1990-91 and turned into a net outflow of US$ 1.6
billion (excluding accrued interest) in 1991-92. The FCNR(A) outflow during 1991-92
was almost one-sixth of its outstanding balances as at end-March 1991, with the bulk of
it moving out in the first quarter (April-June 1991). Due to the provision of exchange
guarantee, RBI made a huge reserve loss. So there was a need for change in the course
of policies.
A positive development of the changes in the policies (as discussed in the following
section and in Chapter 4) was the decline in the proportion of foreign currency
denominated deposits from a high of 78% at end-March 1992 to less than 40% of total
NRI deposits at end-March 2003. Now again the government has introduced the full
repatriability characteristics of all the new NRI deposits. The interest rates on foreign
currency denominated deposits are now closely linked to LIBOR, and banks are
allowed to fix the interest rates on rupee-denominated NRI deposits.
During 1990s, NRI deposits continued to accumulate by a satisfactory amount.
Inflows under FCNR(B) were sufficient to offset the outflows under FCNR(A) but
there were net inflows of US$ 10 billion during the decade under the rupee schemes.
Starting from 1992-93, net inflows on account of NRI deposits showed increasing trend
uninterruptedly till 1994-95. Thereafter it is showing higher volatility with sharp
outflows in some years. The underlying factors behind such heavy outflows may be
identified as domestic or external shocks that are to be tested. But these effects were
short-lived. However, till 2003-04 net NRI deposits showed an overall increasing trend
that was corroborated by the strongly significant positive coefficient of the trend
component (shown in Chart 6.2 below and in the appendix box A.8). During 2004-05,
NRI inflows experienced sharp outflows. This was caused by a huge outflow from the
Non Resident Non Repatriable (NRNR) accounts and very low inflows on account of
NRE deposits. The reason for such low inflows may be the alignment of interest rates

130
on these deposits in tune with the rates of return in the international markets25.
Inclusion of 2004-05 in our trend equation changes the result by lowering both the
significance level of the coefficient of the trend component and the Adjusted R2. The
change in result is more pronounced for quarterly and monthly data. Quarterly data
from 1990-91 onwards do not show significant trend when the sample size is extended
up to the quarter 1 of 2005. But when we restrict our data set up to the first quarter of
2004, net quarterly NRI deposit inflows exhibit positive and significant trend. Monthly
data from January 1999 to December 2005 show negative and insignificant trend
whereas data up to December 2003 show positive and significant trend.
In 2005-06, as the provisional estimate shows, there is a reversal of net capital
inflows on accounts of both FCNR(B) and NRE. There were huge inflows in both the
schemes.
Chart 6.2: Fitting a linear trend to yearly net NRI inflows
4000

3000

2000

2000 1000

1000 0

-1000

-2000
80 85 90 95 00

Residual Actual Fitted

Source of data used: Handbook of Statistics, RBI

6.4: Characteristics of NRI deposits

6.4.1: Volatility of inflows under NRI Deposits

An important feature of NRI deposits is that these deposits, like the domestic term
deposits, can be withdrawn by the holders at any time, subject to the usual penalty of

25
Reports on Currency and Finance (2006), Reserve Bank of India

131
one per cent lower interest rate. However, banks have the freedom regarding whether
they will charge the penalty or not. In addition, FCNR(B) term deposits should have
run for a minimum period of six months to be eligible for interest (except for savings
deposits where no such penalty is applicable). This makes NRI deposits different from
short-term debt as in case of short-term debt, roll-over problems could occur only on
the amortisation date. This option with depositors distinguishes it from other
components of external debt that do not enjoy such facility. The fact that almost entire
non-resident deposits are repatriable also has implications for foreign exchange
markets.
This facility of repatriation of NRI deposits makes them volatile as we see from its
huge withdrawal in the face of the balance of payments crisis of 1990-91. We can also
see that the volatility of NRI deposits did not change over time. Dividing the entire
period from 1990-91 to 2004-05 in two or three sub-periods of equal length, we see that
the coefficients of variation remain more or less the same in different periods26.
Although the Chart 6.3 below shows that NRI deposits are much volatile in the last five
years, actually the coefficient of variation (C.V.) in this period is the smallest due to
much higher mean compared to the standard deviation.

Chart 6.3: Monthly net inflows of FCNR(B) and NRE deposits

1000
800
Amount in US $ million

600
400
200
0
-200
6
98

99

00

01

02

03

04

-0
19

19

20

20

20

20

20

-400
05
20

-600
-800
Year

FCNR(B) net NRE net

Source of data used: Reserve Bank of India Bulletin, RBI, Various issues

To compare the volatility of monthly NRI flows with the quarterly flows, we see
from Table 6.1 below that the C.V. for the quarterly flows for the entire period is 1.29,

26
This is based on quarterly data.

132
whereas that for the monthly flows for the period 1998-99 to 2004-05 is 2.08. This is
not unexpected in view of the withdrawal facilities enjoyed by these deposits.
Volatilities of monthly flows of different types of deposits are different. While
monthly NRE deposit inflows have a C.V. equal to 1.49 for the period 1998-99 to
2004-05, FCNR(B) deposits show high volatility having a C.V. equal to 4.29. This
results from a very low mean of FCNR(B) deposits (35.96 only compared to the
standard deviation equal to 154.44).

Table 6.1: Volatility of NRI deposits

Deposits Mean Standard Deviation Coefficient of
Variation
FCNR(B) (Monthly) 35.96 154.44 4.29
NRE (Monthly) 173.37 259.28 1.49
Total flows (Monthly) 140.62 293.23 2.08
Total flows (Quarterly) 398.47 513.63 1.29
Source: Own calculation based on data from Handbook of Statistics, RBI and Reserve
Bank of India Bulletin

6.4.2: Seasonality of NRI Deposit flows

Gupta and Gordon (2005) found that average inflows in the fourth quarter of a financial
year are substantially higher than those of other quarters and standard deviation of
inflows in the fourth quarter is the lowest. For this quarter the coefficient of variation is
the smallest. But in the data ranging from January 1999 to December 2005 we do not
find any sign of seasonality. Total inflows show seasonality in the month of May
although R2 of the equation estimating seasonality is very low.

6.4.3: Stationarity of NRI Deposit flows

From the monthly net inflows of FCNR(B) and NRE deposits as depicted in Chart 6.3
in the last page, we see that net FCNR(B) flows do not show any trend over time
whereas net NRE inflows seem to be non-stationary (data range from January 1999 to
December 2005). We have carried out unit root tests for these two flows. The result has
been presented in Table 6.3 below. ADF statistics for both FCNR(B) and NRE inflows

133
confirm this finding. The series for quarterly net NRI inflows for the period 1991:4 to
2005:1 is, however, stationary with an ADF statistic equal to –5.932 that is rejected at
one per cent.

6.4.4: Sources of NRI Deposits

Not much information is available on the sources of NRI deposits. Normally banks do
not keep records in that form. Though initially when an account is being opened, the
source country is recorded, in the later years, even if the depositor changes his/her
country of residence, the matter is not recorded. Hence, source-wise inflows, as per the
records available, will not give the true information.
However, Kaul (2000), based on his experiences in the Citibank, gives some
information regarding the sources of different types of NRI deposits. For FCNR(B)
deposits, US and the Middle East together accounted for over 60% deposits in 2000.
The share of US was showing a declining trend. The reason, as identified by Kaul
(2000), is the alternative investment opportunities in stock markets etc. available to the
NRIs of US. The share of the Middle East however was going up. In case of NRE
deposits the share of Asia Pacific was the highest, a little over 30 per cent.

6.4.5: Maturity Profile of NRI Deposits

Available data on the maturity profile of different NRI deposits show that the investors
have a clear preference for deposits with short maturity periods for both FCNR(B) and
NRE deposits. This trend is more or less unchanged over the years. Data from the State
Bank of India (SBI) on outstanding FCNR(B) deposits of different maturities show that
as on December 2005, the share of deposits with maturity period of more than 1 year
but less than two years is the highest (61%)27 in total deposits at the SBI.

6.4.6: Currency Composition of NRI Deposits

As has already been discussed, the preference of investors changed in favour of foreign
currency deposits in the 1980s. In 1990-91, in net NRI deposit inflows, 82 per cent was

27
For this information we are indebted to the office of the NRI Branch in Kolkata, State Bank of India.

134
on account of foreign currency deposits. However, this trend has totally changed in the
1990s when investors’ preference shifted to rupee deposits. Table 6.2 below confirms
this.

Table 6.2: Shares of Rupee and Foreign Currency deposits in Total NRI deposits
Year Total deposits Rupee deposits Foreign currency
In US$ million (US$ million) deposits (US$
million)

1990-91 2136 384 1752

(18) (82)

1992-93 2163 892 1271

(42) (59)

2000-01 2317 1413 904

(61) (39)

2002-03 2976 2450 526

(82.3) (17.7)

Source: Handbook of Statistics, RBI

Note: Figures in brackets are the shares in percent of total

Data on currency composition of FCNR(B) deposits indicates that since initiation

of the deposits denominated in various foreign currencies, investors prefer to hold these
deposits in US Dollar. As Kaul (2000) shows, almost 60-70% of total FCNR(B)
deposits are kept in US Dollars while the second position is assumed by deposits
denominated in Pound Sterling with almost a quarter of total foreign currency deposits.
SBI data also confirm that this remains unchanged over the years. As on December 31,
2005, in total outstanding FCNR(B) deposits held in the SBI, the share of US Dollar
deposits is approximately 69.5%, and those of Pound Sterling, and Euro are 27%, and
3.5% respectively. Japanese Yen claims a negligible share.

6.5: Policies towards NRI deposits

135
After independence, India’s development strategy was that of growth with self-reliance.
Two centuries of British dominance created an antipathy against foreign capital and
initially India relied mainly on domestic savings. The two oil shocks in the 1970s
boosted investment in oil-producing countries and consequently a large number of
Indians were going to the Gulf to take the newly created opportunities of employment.
Those Indians were sending some amount of their savings back to India in the form of
current transfers. To attract more of their savings, Government devised specific deposit
schemes for them. NRIs/OCBs were allowed to open and maintain bank accounts in
India under special deposit schemes - both rupee and foreign currency denominated.
Though NRI deposit schemes were introduced in 1970, without having any significant
benefit for the depositors, these could attract only a meager amount till the early 1980s.
In the 1980s, India’s current account deficits went up to an average of two per cent
per annum. This necessitated the absorption of a higher level of foreign savings. In an
attempt to encourage higher private capital flows into India, special benefit schemes
were derived for attracting the savings of the non-resident Indians, especially of the
increasing number of Gulf-going Indians. In September 1990, a special scheme for
NRIs of the Middle East – FCNR-Special Deposit Scheme – was introduced. Thereafter
several new deposits were created. Sometimes the existing ones were discontinued or
modified according to the requirement of foreign exchange. There were other
incentives also that were changed frequently as necessary. These included higher
interest rates, exemption from CRR or SLR requirement28, 100 per cent tax
concession29, advantages of availing loans by NRIs against the security of these NRI
deposits, provision for holding joint account with a resident etc. As a detailed
chronological account has been given in Chapter 4, we are not discussing these here.
In view of the balance of payments crisis, there was a need for reassessment of the
policies towards NRI deposits. As a result, the rest of the 1990s saw a bundle of policy
adjustments towards increasing the non-repatriable component of the total deposits as
well as making the deposits stable through changes in the maturity pattern. The policies

28
Reserve requirement on external deposits with the domestic banking system has direct impact on the
quantum and nature of external capital flows by influencing the cost of such funds/return on such
deposits. Emerging countries impose differential reserve requirements on different types of deposits
according to their need for foreign exchange. Some other emerging countries that follow this instrument
of control are Philippines, Singapore, Columbia, Croatia, Slovenia, Saudi Arabia, Macedonia, Kenya,
Syria, China, Egypt, Poland, Peru, Thailand, Korea, and Israel etc.
29
According to Kaul (2000), these tax exemptions are encouraging as NRIs don’t disclose these deposits
in their residing countries.

136
attempted to retain the attractiveness of these schemes to maintain the capital flows
from abroad, while at the same time, reducing the effective cost of borrowing in terms
of interest outgo and the cost to macroeconomic management. The Government
adopted new policies by (1) encouraging rupee-denominated NRI deposits, (2) reducing
the repatriable component in total deposits and (3) shifting the exchange risks of
foreign currency denominated deposits back to the banks by phasing out the FCNR(A)
scheme and introducing an alternative foreign currency denominated scheme,
FCNR(B), under which the foreign exchange risk was to be borne by the banks. Along
with it, the interest rates on these deposits have been gradually deregulated.
As the situation began to improve, in the late 1990s policies were changed towards
(1) rationalising the interest rate on rupee-denominated deposits, (2) linking the interest
rates to LIBOR for foreign currency denominated deposits, (3) keeping the interest rate
differential between FCNR(B) and international rates very low to discourage arbitrage,
and (4) deemphasizing short-term foreign currency deposits (up to 12 months). RBI
changed CRR and SLR on these deposits occasionally to regulate the size of the
inflows depending on the country’s requirements. The minimum maturity of FCNR(B)
deposits has been raised from six months to one year. Above all, there was a need for
pursuance of sound macroeconomic policies to stabilize the capital flows. Currently
India is continuing with two fixed deposit schemes – NRE & FCNR(B) – both of which
are fully repatriable.
In our empirical exercise we have tested the effect of increasing the maturity period
of NRE deposits. The effects of changes in CRR on NRE deposits could not be
captured as for NRE deposits there was no significant change after January 1999 and
the period of change in CRR with respect to FCNR(B) deposits coincided with the
period of lengthening the maturity of FCNR(B) deposits. There was no change in SLR
in the post- January 1999 period for either of these deposits.

6.6: Finding out the Determinants of NRI deposits

6.6.1: Possible Determinants of NRI deposits: Survey of the Literature

137
From the survey of the literature, as presented in Chapter 3, on the determinants of NRI
deposits, we find the following variables likely to determine NRI deposits:
(a) Interest rates offered on these deposits
(b) Interest rates in the world market
(c) Expectation towards future exchange rates
(d) Oil prices
(e) Returns on stock exchanges
(f) Foreign exchange reserves
(g) Currency crisis
(h) Lengthening of maturity period
(i) Political events
(j) Introduction of new and/or discontinuation of existing
deposits
(k) Change in sovereign rating
(l) Change in CRR and SLR
(m) Introduction of RIB and IMD

In our work, we have considered from the above list the variables that have been found
to be significant and some other variables too that we think are likely to be significant.
Some of the variables have not been considered as they do not seem to be important for
the period we have taken up for regression.

6.6.2: Determinants of NRI deposit inflows: Estimation

6.6.2.1: Variables considered for regression

Dependent Variables

We have considered two different dependent variables: monthly net FCNR(B) flows
(FCNR) and monthly net NRE flows (NRE). We have to consider rupee and foreign-
currency denominated deposits separately as the determinants of these two deposits are
not same. The existing literature also, as discussed above, reaches to such a conclusion.
Hence these two types of deposits need to be taken separately. We have not considered

138
total NRI deposits as there would be problems in finding out the proper interest rate
differential variable for such an aggregated series. Using any particular interest rate
series may give biased results.

Explanatory variables for net FCNR(B) flows:

1. Interest rate differential on FCNR(B) deposits: Data on net FCNR(B) deposit

include data on inflows under varying maturities. Interest rates on deposits of
varying maturities are different. But data are not available separately for
different maturities. We use the fact that the deposits of the shortest maturity
period (i.e., 1 year) claim the highest share. So we use two interest differentials.
One (INTDIF) is calculated as the difference between 1-year US dollar LIBOR
rates and interest rates on FCNR(B) deposits of maturity of one year. Another
(INTA) is taken as the difference between 1-year US dollar LIBOR rates and
average interest rates on FCNR(B) deposits of all the maturities. We take
LIBOR rate as in the foreign currency denominated deposits, US dollar deposits
claim nearly 80 per cent.
2. Returns on stock exchanges: Next we consider returns on stock exchanges, one
for investment in the developed countries and another for investment in India.
These are included to capture the effects of alternative investments. So our
relevant variables are monthly return on MSCI world index (WORRET) and
monthly return on BSE National Index (BSERET).
3. International crude prices (OIL): In the existing literature as mentioned in the
survey of the literature, OIL is taken as a proxy for income of the NRIs. Since
the majority of deposits do not come from oil-producing countries, this may not
be a right proxy for NRI’s incomes. However, we consider it as one proxy along
with US GDP growth rate as another proxy. Again, rise in oil prices may exert a
negative influence on the Indian economy by raising the current account deficit.
4. US GDP growth rate (USGR): The reasons for including US GDP growth rate
are twofold. It may act as a proxy for income of the NRI’s, in which case there
is the same problem as with OIL. On the other hand, higher growth rate in US
may imply higher investment opportunities for NRIs in the US. This may have a
negative influence on NRI deposit inflows here.

139
 5. Volatility of exchange rates (CVEX): The exchange risk for FCNR(B) deposits
is either borne by the RBI or by the depository banks, while that for NRE
deposits is to be borne by the depositor himself. So, volatile exchange rates may
lead to a shift of NRIs’ preferences towards FCNR(B) over NRE.
6. Dummy for issuance of IMD (IMD): As IMD was like a foreign currency
deposit and offered higher interest, it was expected to affect inflows on account
of FCNR(B) adversely. We take 1 for the months in which IMD was in the
market and 0 for other months.
7. Dummies for sovereign rating (DR and DO): Rating dummy (DR) takes value 1
for the period when the rating was BB+ and 0 for other periods. Dummy for
outlook towards foreign currency sovereign rating (DO) takes value 1 for the
periods when outlook is stable or positive and 0 for the periods when outlook
was negative.
8. Dummy for political event. (POL): POL has been taken to be 1 for the month of
twin tower blast and the following month, and 0 for other months.

We have not considered dummies for SLR, CRR or lengthening of maturity period.
There was no change in SLR in the period we consider. From November 1999,
incremental CRR on FCNR(B) was withdrawn and in the same month, maturity period
of FCNR(B) deposits was increased from six months to one year. The effect of
withdrawal of CRR should be positive for FCNR(B) inflows whereas lengthening of
maturity period is expected to affect them adversely. Thus considering these two
dummies may give misleading results. Hence we do not consider these two dummies.

Explanatory variables for net NRE deposits:

1. NRE interest rates minus rupee depreciation over the past 12 months
(RETURN): As the NRIs keeping money in NRE deposits have to bear
exchange risk themselves, the expectation towards the future exchange rate
plays an important role in determining the volume of inflows in NRE deposits.
Here we have calculated first the expected changes in the real effective
exchange rates (REER) after 12 months. REER has been taken to capture the
fact that for NRE deposits, foreign exchanges come in various currencies.

140
 RETURN has been calculated as the current average interest rates on NRE
deposits minus expected change in exchange rates after 1 year. The trend of
RETURN is the same if we consider the interest rates on 1-year NRE deposit
instead of average interest rates of all maturities.
2. LIBOR: 1-year LIBOR rate has been taken separately as an explanatory
variable as this represents the opportunity cost of investing money in India
instead of investing in the world market.
3. Volatility of exchange rates (CVEX): CVEX is expected to exert a negative
effect on NRE deposits as volatility of exchange rates increases the uncertainty
of return from rupee deposits.
4. Foreign exchange reserves (FOREX): Building up of reserves was taken to be a
source of comfort for the investors of NRE as it reduces the risk of default on
the part of the country at the time of repatriation. In case of FOREX, to avoid
simultaneity we have taken lagged forex reserves, i.e., FOREX(-1).
5. Dummy for the effect of discontinuation of NRNR deposit scheme (NRNR):
When NRNR scheme was withdrawn the balances left in the account could be
shifted to NRE deposit accounts. After this came into effect, there was a huge
increase every year in NRE deposits. So we test the effect of NRNR. The value
of NRNR was taken to be 1 for the period on and from NRNR was
discontinued, and 0, otherwise.
6. OIL: The explanation for including OIL is the same as we have given for
FCNR.
7. USGR: The explanation for including USGR is the same as we have given for
FCNR.
8. Dummy for increasing maturity period of NRE deposits (MATURITY): The
value of MATURITY is taken to be 1 for the period on and from the maturity
period was increased to 1 year and 0 for the earlier periods. The coefficient is
expected to be negative.
9. Local Currency Sovereign Credit Rating (DOL): As these deposits are in
rupees, we have considered sovereign credit rating based on local currency.
Value of DOL has been taken to be equal to 1 for those periods in which rating
was BBB and 0 otherwise.

141
 10. POL: POL dummy has been taken for twin tower blast in the similar way as we
did for FCNR.

6.6.2.2: Sample period considered for regression

Though in the previous chapter we have taken quarterly data for finding out the
determinants of inflows of ECB, here we consider monthly data. Since monthly data
are available, using quarterly data will lead to a smaller data size so that we will lose a
lot of information. Separate data on different types of NRI deposits are available on
monthly basis on and from 1994. But we consider here data from January 1999 due to
two reasons. From April 1998, interest rates on NRI deposits were freed and this
creates a new regime for these deposits. Secondly, the existing literature has considered
data that were mainly of pre-Asian crisis period. Here we want to check whether there
has been any change in the determinants in the post- Asian crisis period. Therefore
most of our explanatory variables match with those considered in the earlier studies.
However, we have considered new variables also. The dummy variables have been
different too as all of them are not valid for our period. The entire 1998 being crisis-
affected, the starting date of our exercise is January 1999.

6.6.2.3: Unit Root Tests of the Dependent and the Explanatory variables

In Table 6.3 below, the result of the unit root tests done with optimal lagged differences
separately for each variable is reported. Here the model also is selected by applying the
model selection criteria as defined in Chapter 1. We see that the FCNR series is I(0)
whereas NRE series is I(1). The explanatory variables are selected accordingly for
regression. In case of FCNR, there are two explanatory variables that are I(1). They are
OIL and USGR. On the case of NRE, among the explanatory variables, there are more
than one I(1) and I(0) variables. To run regressions taking more than one I(1) variables
in the regression, we need to ensure that the I(1) variables are cointegrated. We also
have to ensure that such I(1) variables, when used simultaneously do not lead any
multicollinearity problem. So we have checked the correlations between the
explanatory variables. The correlations are given in the appendix Tables A2 and A3.

142
 For FCNR, we find that there are high correlations between DR and Oil. This
correlation does not seem to be very meaningful. For NRE, we find that there are high
correlations between (LIBOR, RETURN), (RETURN, OIL) and (OIL, FOREX(-1)).
Correlations between the last two pairs do not seem meaningful. For the first pair, we
see that our regression results do not show any sign of multicollinearity.

Table 6.3: Result of the Unit Root Tests of the FCNR(B) and NRE deposit inflows
and their explanatory variables

Variable ADF Test p-value 1% 5% critical Conclusion

Statistic Critical value
value
FCNR -6.29 0.000 -3.5 -2.89 I(0)
INTDIF -2.67 0.009 -2.59 -1.94 I(0)
OIL -1.509 0.135 -4.07 -3.46 I(1)
dOIL -9.21 0.000 -3.51 -2.89 I(0)
USGR -1.71 0.090 -3.51 -2.89 I(1)
dUSGR -11.28 0.000 -2.59 -1.94 I(0)
BSERET -6.94 0.000 -2.59 -1.94 I(0)
WORRET -8.82 0.000 -2.59 -1.94 I(0)
CVEX -3.2 0.002 -3.51 -2.89 I(0)
NRE -1.99 0.049 -3.50 -2.89 I(1)
dNRE -8.5 0.000 -2.59 -1.94 I(0)
RETURN -1.323 0.189 -2.59 -1.94 I(1)
dRETURN -6.109 0.000 -3.51 -2.89 I(0)
LIBOR -0.631 0.529 -2.59 -1.94 I(1)
dLIBOR -3.817 0.000 -2.59 -1.94 I(0)
FOREX -1.563 0.121 -4.08 -3.47 I(1)
dFOREX -5.987 0.000 -4.08 -3.46 I(0)
Source: Own calculation
Note: ‘d’ before a variable implies the first difference of the variable

6.6.2.4: Testing cointegration of the I(1) variables

143
For FCNR, we check whether Oil and USGR are cointegrated or not. The result of the
Johansen’s cointegration test is reported in Box 6.1. Here the data is generated by a
linear deterministic trend and the cointegrating equation contains an intercept term but
no trend. The result indicates that the hypothesis of no cointegrating equation is
rejected implying that there is cointegration between OIL and USGR. However, as we
find from Table A.2, there is no significant correlation between OIL and USGR (the
correlation being only 0.28).

Box 6.1: Result of the Johansen’s Cointegration Test of some determinants of

FCNR

Sample: 1999:01 2005:12

Included observations: 81
Test assumption: Linear deterministic trend in the data
Series: OIL USGR
Lags interval: 1 to 2
Likelihood 5 Percent 1 Percent Hypothesized
Eigenvalue Ratio Critical Critical No. of CE(s)
Value Value
0.245412 22.90721 15.41 20.04 None **
0.001221 0.098974 3.76 6.65 At most 1

*(**) denotes rejection of the hypothesis at 5%(1%) significance level

L.R. test indicates 1 cointegrating equation(s) at 5% significance level

6.6.2.4: Results

Dependent variable: FCNR

We have tried several regressions with alternative specifications. The results of some of
the representative regressions are presented in Table 6.4 in the next page.

144
 Table 6.4: Regression results with FCNR as the Dependent Variable
I II III IV V VI

C -26.1 -16.99
(0.76) (0.64)
FCNR(-1) -0.22* -0.20* -0.2* -0.18 -0.17 -0.19*
(0.07) (0.06) (0.06) (0.11) (0.12) (0.08)
DS 84.3 85.4* 86.9* 83.3* 92.61* 87.59*
(0.10) (0.07) (0.07) (0.08) (0.05) (0.06)
INTDIF 21.7 30.04 21.7 36.96* 32.10
(0.37) (0.12) (0.33) (0.06) (0.10)
CVEX 68.25** 47.49*** 58.59*** 41.8*** 45.03*** 57.12**
(0.01) (0.00) (0.00) (0.00) (0.0001) (0.02)
USGR -4.49 -4.28
(0.57) (0.54)
OIL 0.79 0.017
(0.73) (0.98)
BSERET 6.26 -31.4
(0.97) (0.86)
WORRET 60.5
(0.86)
DO -10.7
(0.76)
DR -18.9
(0.79)
POL 27.6
(0.78)
IMD -60.3
(0.54)
DUSGR -20.3** -19.35**
(0.01) (0.02)
DOIL 5.54
(0.30)
R2 0.161 0.146 0.153 0.120 0.201 0.192

Adjusted R2 0.019 0.114 0.099 0.088 0.149 0.140

AIC 12.650 12.454 12.493 12.483 12.435 12.446
SIC 13.029 12.570 12.667 12.599 12.610 12.462
F statistic 1.14 3.67***

D-W / 1.86 1.89 1.88 1.9 1.85 1.87

Durbin’s h

145
statistic
Sample size 84 84 84 84 83 83
Note: Figures in parentheses are p-values.

Interpreting the Results:

1. The only variable that affects net FCNR inflows significantly is CVEX. The
positive coefficient of CVEX implies that when exchange rate is volatile,
uncertainty of a stable return from the investment in NRE deposits increases. As
a result, investors shift their money to that deposit that does not involve an
exchange risk. Thus FCNR(B) deposits increases.
2. Although FCNR does not depend significantly on the past values, it seemed that
the past values of FCNR have some effects on current FCNR as the regressions
involving FCNR(-1) in the set of explanatory variables give slightly better
results in terms of adjusted R2 and AIC than the ones excluding FCNR(-1).
Excluding FCNR(-1) gives better result in all the specifications if we consider
SIC. However, it should be noted that these parameters for choosing a better
model vary slightly in these regressions with or without FCNR(-1).
3. The above finding holds also for DS. It was found that although FCNR does not
show significant seasonality and DS is not significant either at 1 or 5 per cent
except for two specification, inclusion of DS in all the regressions presented
here gives better results in terms of adjusted R2 and AIC. SIC is, however, lower
when DS is not included.
4. Interest rate differential does not seem to affect FCNR significantly. It is to be
noted that from April 1998, interest rates on FCNR(B) were linked to LIBOR
and the differential between interest rates on FCNR(B) deposits of various
maturities and LIBOR rates of corresponding maturities were kept at a very low
level. Hence the interest differential fails to exert any significant impact on
FCNR(B) inflows.
5. The effect of IMD is ambiguous. Though in specification I, IMD has the normal
negative sign, in some other regressions, the coefficient becomes positive. On
the one hand, IMD offering higher interest rates may offset FCNR inflows. But
on the other hand, this particular measure of issuing IMD by the Government in

146
 the face of an emerging crisis on the external account might have increased
investors’ confidence leading to higher inflows. The actual effect thus depends
on the interplay of various other explanatory variables. However, the effect is
insignificant in all the cases.
6. Investment in stock exchanges in India should be a substitute for FCNR(B)
deposits. But in a number of regressions, we found that the coefficient of
BSERET was positive. However the coefficient of BSERET is insignificant.
7. The positive coefficient of WORRET implies that if NRIs earn higher from
investing in the global capital market, they remit some of this earning to
FCNR(B) deposits. But the coefficient being insignificant, we cannot assume
any relationship between WORRET and FCNR.
8. In line with the earlier studies we see that sovereign rating and outlook does not
have any impact on FCNR. In fact, their signs are ambiguous and misleading
too in many of the regressions.
9. The uncertainty among NRIs, especially those in the US, after twin tower blast
might have forced them to remit more money in India. But the effect is not
significant.
10. In specifications V and VI, we have presented the result of the regression with
DUSGR and DOIL (first differences of USGR and OIL respectively) as our
explanatory variables instead of USGR and OIL. We see that the coefficient of
DUSGR is negative and significant. Also the model becomes better in all
respect. We have run several regressions with different specifications where
either both of DUSGR and DOIL or DUSGR alone has been taken instead of
USGR and OIL. The results are, in all the cases, better.
11. The negative and significant coefficient of DUSGR means that as growth rate in
the US increases at increasing rate, prospect from investment in the US is
higher. This possibility of getting higher returns from an investment alternative
to FCNR(B) deposits leads to fall in inflows in FCNR(B) accounts. Another
reason for this negative effect is that increase in US growth rate increases rate of
interest to be received in the US. As a result, expectations relating to US dollar
and interest rate changes against investments in India. When the level a variable
(FCNR) is explained by the change in the explanatory variable (DUSGR) one

147
 misses the scale effect. But as the growth rate changes very slowly, in our case
the scale effect is not very significant.
We have tested the effect of S&P index that is an important US stock index
instead of DUSGR. The relation is, as expected, negative but insignificant.

Dependent variable: NRE

We have run regressions with two specifications of the dependent variable – net NRE
inflows (NRE) and logNRE. The results are presented in Table 6.5 and 6.6 below.

Table 6.5: Regression results with NRE as the Dependent Variable

I II III IV V VI
C -487.5** -534.7*** -466.6* -193.5 -458.0* -264.0
(0.01) (0.003) (0.06) (0.48) (0.06) (0.39)
NRE(-1) 0.23** 0.24** 0.23** 0.24** 0.11
(0.02) (0.01) (0.03) (0.01) (0.34)
RETURN 96.81*** 101.61*** 96.8*** 81.5*** 90.15*** 114.4***
(0.0001) (0.0000) (0.0008) (0.005) (0.009) (0.0076)
OIL -2.29 -2.82 7.5
(0.47) (0.44) (0.27)
USGR 1.68 5.85
(0.89) (0.65)
MATURITY -47.38 116.6
(0.66) (0.41)
NRNR 472.8*** 434.15*** 479.8*** 608.1*** 428.26*** 521.3***
(0.0002) (0.0001) (0.0002) (0.000) (0.0001) (0.0002)
LIBOR -54.00** -63.78*** -49.9* -62.6*** -58.43*** -77.59**
(0.01) (0.0007) (0.08) (0.002) (0.009) (0.01)
FOREX(-1) -0.004** -0.007**
(0.02) (0.02)
BSERET -8.15
(0.97)
WORRET -54.6
(0.92)
CVEX -2104.6
(0.62)
DOL -241.9**
(0.04)
POL 87.06
(0.56)
Sample size 84 84 84 78 84 78
R2 0.531 0.528 0.532 0.534 0.529 0.593
Adjusted R2 0.501 0.504 0.476 0.509 0.499 0.533
AIC 13.380 13.363 13.472 13.415 13.384 13.433

148
SIC 13.554 13.508 13.762 13.566 13.558 13.766
F-statistic 17.67*** 22.10*** 9.38*** 17.54*** 9.79***
D-W 2.06 2.08 2.06 1.60 2.07 2.04
statistic
Durbin’s h -1.07 -1.11 _ _ -1.04 _
statistic
Note: Figures in parentheses are p-values.
The dependent and most of the explanatory variables except the dummies are I(1). We
have checked for each regression whether the particular combination of I(1) variables
in the regression is I(0), i.e., whether the I(1) variables used in the regression are
cointegrated. As we see from Box 6.2, a combination of all the I(1) series taken
together, i.e., NRE, OIL, LIBOR, RETURN, USGR and FOREX are cointegrated,
though not perfectly. We have tested cointegations for all other combinations of I(1)
variables used in different regression equations reported in Table 6.6. The results are
given in appendix Boxes A.9 to A.12. We see that all the combinations are I(0). So we
have been able to use different combinations of I(1) variables with the I(0) variables.

Box 6.2: Result of the Johansen’s Cointegration Test of NRE and some of its
determinants

Sample: 1999:01 2005:12

Included observations: 75
Test assumption: Linear deterministic trend in the data
Series: NRE OIL LIBOR RETURN USGR FOREX
Lags interval: 1 to 2
Likelihood 5 Percent 1 Percent Hypothesized
Eigenvalue Ratio Critical Critical No. of CE(s)
Value Value
0.534907 131.7271 94.15 103.18 None **
0.324598 74.31324 68.52 76.07 At most 1 *
0.234344 44.87971 47.21 54.46 At most 2
0.188155 24.85303 29.68 35.65 At most 3
0.105318 9.219569 15.41 20.04 At most 4
0.011574 0.873082 3.76 6.65 At most 5

*(**) denotes rejection of the hypothesis at 5%(1%) significance level

L.R. test indicates 2 cointegrating equation(s) at 5% significance level

149
Interpreting the Results of Table 6.5:

1. From Table 6.5, it is clear that depositors who maintain Rupee deposit accounts
in India are basically return-seekers. The coefficient of return is positive and
significant in all the specifications. We have also considered an alternative
index for return where instead of percentage change in spot exchange rate, we
have taken 6-month forward exchange rate as a proxy for expectation towards
future exchange rate. But the effect is less pronounced as the adjusted R2, AIC,
SIC etc. become worse. Even in some of the specifications, the coefficient of
this newly constructed return variable is insignificant.
2. Monthly net NRE inflows depend positively and significantly on net inflows in
the preceding month. This may imply that more NRE deposits in the last month
gives a favourable signal to the depositors and they invest more in the current
month. From a different angle we can interpret it as so long there is no chance
of any crisis in the economy or the return seems to be stable in the near future,
non-residents who are willing to invest in their home country, feel encouraged
and thus inflows show an increasing trend over time.
3. The effect of 1-year LIBOR rate is negative and significant implying when the
return from an alternative investment opportunity is higher, depositors respond
accordingly by keeping less money into these deposits.
4. The constant term that has a negative effect on net inflows of NRE deposits is
also significant in most of the specifications.
5. Discontinuation of NRNR deposits and subsequent transfer of money on
renewal from NRNR deposit accounts had raised significantly the inflows in
NRE accounts. The coefficient of NRNR dummy is positive and highly
significant in all the specifications.
6. We have also tested the effect of volatility of exchange rate (measured by the
coefficient of variation of real effective exchange rates) on net NRE deposit
inflows. The effect is negative but insignificant. As in case of rupee deposits,
depositors themselves have to bear exchange rate risk, they keep less money
into these deposits when volatility of exchange rate increases. This fact becomes
more pronounced as we find that in case of net FCNR inflows, the effect is
opposite. This is so as by keeping deposits into FCNR(B) accounts, depositors

150
 do not have to bear any exchange risk (that being borne by the banks), and in
the face of reduced volatility of exchange rates (as the Indian experience shows)
they feel encouraged to keep deposits in NRE accounts instead of FCNR(B)
accounts.
7. US growth rate also does not affect NRE deposit inflows significantly. The sign
of the coefficient also varies across specifications.
8. The coefficient of OIL is, contrary to the earlier works, negative30 and
insignificant. However it seems from the regressions that the effect of OIL is
partly captured by LIBOR as including LIBOR in the regressions
simultaneously with OIL makes the coefficient of OIL insignificant. In
specification III, where LIBOR is not included in the regression, the coefficient
of OIL is significant. However, the model with LIBOR and without OIL in the
set of regressors is better in all respects than the ones with OIL only and with
both OIL and LIBOR (specifications I, II and III). Also the coefficient of OIL
becomes positive, although insignificant, when more and more explanatory
variables are included in the regression (specification VI).
The effect of OIL on FCNR(B) deposits is just the opposite. A rise in oil
price increases, though not significantly, FCNR(B) inflows as the risk of
depreciation of rupee in the face of rising oil price induces the NRIs to shift
their money from NRE to FCNR(B) deposits.
9. Inflows on account of NRE deposits suffer when the maturity period is
increased 31 from six months to one year. Interestingly, in specification VI, the
effect is positive. However, the effect is not significant in any one regression.
10. Another interesting result comes from lagged forex reserves. As forex reserve
increases in the last period, net NRE deposit inflows fall. It may seem that as we
include both lagged NRE and lagged FOREX in an equation, the result suffer
from multicollinearity (as increased NRE inflows in a period increases foreign
exchange reserves in that period). But our regression results do not show any

30
Gordon and Gupta (2005) justify the inclusion of change in the price of oil as a proxy for change in the
income of NRI depositors. In that case the coefficient should be positive. But in our result it is negative.
The reason is that an increase in oil price is supposed to affect our economy adversely through two
routes: (a) an increase in current account deficit will lead to depreciation of rupee and (b) there will be a
fall in the growth of the real economy. These two together affect expectation of future returns of NRE
deposit holders adversely. The explanation of Gordon and Gupta (2005) does not seem to be right as not
more than one-third of NRI depositors are from oil-producing countries.
31
This is in line with what Kaul (2000) emphasized.

151
 presence of multicollinearity. Also, we find that the correlation between NRE(-
1) and FOREX(-1) is very small. In specification II, we have replaced NRE(-1)
and by FOREX(-1) and get specification IV. We see that the result worsens in
terms of AIC and SIC. Comparing specifications IV and VI, we find that
whether we include both NRE(-1) and FOREX(-1) in the same equation or
include FOREX(-1) only, the sign of the coefficient of FOREX(-1) is negative
and significant in both the cases. However, the coefficient of forex is so small in
relation to other variables that the effect might be ignored.
11. The alternative investment opportunity for NRIs in India seems to have no
significant impact on net inflows though NRE deposits. We have tested the
effects of BSERET and WORRET. The coefficient of BSERET is negative but
insignificant and that of WORRET is also insignificant.
12. Sovereign rating or outlook does not have any significant impact on NRE.
Although in most of the cases we have tried the coefficient of DOL is positive
and insignificant, in specification VI, it is negative and significant. In this case,
it seems that DOL captures some other effect.
13. Although twin tower blast and the consequent uncertainty made NRIs remit
more money to NRE deposit accounts the effect is not significant.

Dependent variable: Log NRE (nre)

The problem with the specification in logarithms is that in case of negative inflows the
log values are not available; hence we loose a number of observations here.
In case of log NRE lagged dependent variable is not included as logarithm values
are not available for negative observations. Thus lagged dependent variable in this case
is not meaningful, as for all the observations of the dependent variable the lagged
values may not be the values with the same lag. In the following Table 6.6, we present
some of the regressions that give lower AIC and SICs than the other regressions. In the
Table all the explanatory variables except the dummy NRNR are in log. The results as
presented in Table 6.6 more or less confirm the results of the regressions with NRE.
Here the significant variables are return, libor and NRNR. The constant term is also
significant in some of the regressions. We find that exchange volatility is now
significant in one or two regressions. The coefficients of all other explanatory variables

152
remain the same except that of usgr. In Table 6.5, USGR was positive but log(USGR)
is negative.

Table 6.6: Regression results with nre (LogNRE) as the Dependent Variable
I II III IV V VI
c 2.34** 9.41 15.58* 2.46** 12.35 3.59*
(0.01) (0.25) (0.09) (0.01) (0.20) (0.05)
return 1.43*** 1.06* 0.47 1.38*** 0.27 1.30***
(0.001) (0.08) (0.51) (0.003) (0.69) (0.006)
libor -0.75*** -0.79** -0.63* -0.71** -0.58*
(0.008) (0.01) (0.07) (0.01) (0.09)
oil -1.15* -0.39
(0.08) (0.43)
usgr -0.07 -0.06 -0.17
(0.63) (0.66) (0.26)
forex(-1) -0.59 -1.29 -0.76
(0.39) (0.12) (0.42)
cvex -0.57 -0.76*
(0.15) (0.05)
NRNR 1.76*** 1.91*** 2.08*** 1.79*** 2.49*** 1.97***
(0.0000) (0.0008) (0.0004) (0.0000) (0.0000) (0.0000)
R2 0.477 0.485 0.506 0.478 0.506 0.482
Adjusted 0.452 0.449 0.452 0.444 0.452 0.448
R2
AIC 2.647 2.723 2.745 2.674 2.746 2.667
SIC 2.779 2.894 2.985 2.84 2.986 2.833
F statistic 18.87*** 13.43*** 9.41*** 14.01*** 9.39*** 14.22***
D-W 2.35 2.34 2.46 2.36 2.46 2.37
Sample 66 62 62 66 62 66
size
Note: Figures in parentheses are p-values.

In Charts 6.4 and 6.5 below, we present the graphs showing actual, fitted and
residual series for FCNR and NRE. Here the best specifications are taken as the
representatives. From the regressions above we can identify some months when inflows
have not been explained by the regressions. We have checked the graphs for all the
specifications for both the variables. The results are the same.
As can be seen from Charts 6.4 and 6.5, there is one month for FCNR and three
months for NRE in which inflows have not been explained well by our regressions. In
October 2003, both the actual FCNR and NRE inflows have been much higher than

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what the fitted regression shows. Similarly, for NRE inflows, in May 2004, inflows
have been much lower and in March 2005, those have been much higher than what the
fitted regressions show. As the other observations are more or less correctly explained,
it seems that in those months there were some external shocks that could not be
captured by our explanatory variables. We should try to find out some possible events
that might have affected NRI deposit inflows in those months.

Chart 6.4: The actual, fitted and residual series of FCNR

800
600
400
200
600
0
400 -200
200 -400

-200

-400
00 01 02 03 04 05

Residual Actual Fitted

Chart 6.5: The actual, fitted and residual series of NRE

1000

500

1000
0

500
-500

0
-1000

-500

-1000
99 00 01 02 03 04 05

Residual Actual Fitted

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 In September 2003, OCBs was derecognised in India as an eligible class of investor
under various routes/schemes available under the Foreign Exchange Management Act
(FEMA). They were barred from making fresh investments under FDI schemes,
purchase of shares/convertible debentures, purchase of Government dated securities or
Treasury Bills or units of domestic mutual funds, lending in foreign currency to
residents and to open and maintain non-resident deposit accounts. This decision might
have a negative impact on both types of inflows. Another important policy change that
might have some positive impact on NRI deposits is that the balances in the exchange
earners’ foreign currency (EEFC) and RFC accounts were allowed to be credited to
both NRE and FCNR(B) accounts at the option of the account holders consequent upon
change of residential status (to nonresident). But this should have a more prolonged
effect. It is surprising why NRI deposits in a particular month suddenly increased so
much.
The result of the Lok Sabha election in India was published in the second week of
May 2004. The fall of the then ruling NDA government created an uncertainty
regarding the policies to be followed by the new Government. As a result, FII flows
reacted by flowing out sharply immediately after the result was published. This may
have also caused the fall in NRE.
In general, our regressions could not explain the volatility of net NRE deposit
inflows since 2003. Interest rates on fresh NRE deposits were changed frequently since
2003. It may have caused an uncertainty in the mind of NRIs regarding the
Government’s attitude towards this scheme. This may be a reason for such high
volatility of net NRE inflows in this period.

6.7: Summary and Conclusion

In this chapter we have analysed the trend and determinants of inflows under two types
of NRI deposits in India. NRI deposits scheme is one of the oldest avenues of attracting
private capital flows to India and policies towards these deposits were modulated
frequently according to the position of the balance of payments accounts. As the data
reveal, these policies are more of less successful to achieve its targets.

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 Quarterly inflows of net NRI deposits since 1990-91 show much stability. In the
post-Asian crisis period, FCNR(B) became much volatile and did not show any
increasing or declining trend. The volatility may be caused by the uncertainty arising
out of frequent changes in the interest rates offered to such deposits. Net NRE deposit
inflows however continue to be much stable and also assuming increasing share in total
deposits since 1991-92. These two types of deposits together contribute a substantial
amount of foreign capital inflows still now. Though interest rate advantage given to
these deposits was one of the channels through which these deposits were made
attractive, there has been a continuous flow of them even in the face of insignificant
interest differential. This fact necessitated a detailed study of the determinants of such
deposits.
The econometric result shows that incentives other than high interest rates are still
in play to attract FCNR(B) deposits. Lower return in the US market also plays an
important role. On the other hand, in case of NRE deposits, return from investing in
India plays the most prominent role. Volatility of exchange rates becomes an important
factor to determine relative shares of FCNR(B) and NRE deposits.
We tried to carry out a more thorough study of NRI deposits incorporating the
differences in region-wise inflows. But due to the lack of information as mentioned
earlier we could not attempt such exercise. A study on such disaggregated data, if
possible, will really be worthwhile to find out the determinants of such deposits.
To conclude, we see that appropriate policies together with stable economic
situation is necessary to maintain a steady level of inflows under NRI deposits. Policies
should be directed towards keeping these deposits free from any uncertainty so that we
do not have to face situations of large outflows of these deposits, as was the case in
1991. Also, more flexibility in charging interest rates as well as offering other benefits
to the deposit-holders should be given to the banks that are attracting NRI deposits.

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