The Reserve Bank of India on Monday further tightened the interest rate on repatriable non-resident external rupee (NRE) deposits. The move will put rupee (NRE) and dollar (FCNR-B) deposits on a par and kill any arbitrage opportunity.

The RBI said the interest rate on NRE deposits could not exceed 100 basis points above the London Inter-Bank Offered Rate (Libor)/SWAP rates for the US dollar of corresponding maturity.

"On a review of the interest rates offered to non-resident Indians, it has been decided that, until further notice the interest rates on fresh repatriable NRE deposits for one to three years contracted from the close of business hours on September 15 in India, should not exceed 100 basis points above the Libor/SWAP rates for US dollars of corresponding maturity," an RBI release said.

The move to reduce the NRE deposit rates will have an impact on the State Bank's proposal to retain bulk of the Resurgent India Bond proceeds by floating two new schemes.

With one-year Libor veering around 1.30 per cent, the interest rates on NRE deposits will work out to around 2.3 per cent.

This means that on a fully-hedged basis (with the depositor taking the forward cover), return to the depositor will be around 1 per cent or so (as one-year forward cover costs around 1.3 per cent).

The return on dollar-denominated foreign currency non-resident-bank (FCNR-B) is around 1.05 per cent now (as it is capped at 25 basis points below Libor).

In other words, the RBI has brought parity between the returns on rupee denominated and dollar denominated NRI deposits and removed further any arbitrage opportunity.

"Earlier forward premia were ruling high. Since the premia have come down now, the RBI realigned the NRI deposit rate structure," said a senior banker. The objective is to stem the arbitrage opportunity between domestic and overseas interest rates.

On July 17, the RBI imposed a ceiling on interest rate on repatriable NRE deposits. Then the central bank said that banks could not pay more than 250 basis points above the Libor/SWAP rates for US dollar of corresponding maturity.