While the world is awaiting the arrival of what is being billed as one of the most powerful currencies which has the potential to upstage the American dollar, the Indian central bank -- like all other central banks the world over -- is busy drawing up plans on how to compensate for the loss of a lucrative income stream: arbitraging between the bond, currency and money markets across Europe.

"After the introduction of the single currency euro, the arbitrage market will cease to exist," a senior official in the RBI points out. The RBI is also in the process of changing the currency baskets in the foreign exchange reserves by replacing the deutche mark with the euro in a phased manner.

"Most of the legacy currencies, including the Frach franc and the German DM, will be phased out. The currency basketwill mainly consist of four currencies -- the US dollar, pound sterling, Japanese yen and the euro," the official said. Once the UK joins the Eurozone, the RBI will be required to phase out pound sterling as well.

At the end of 1996, European Union currencies together accounted for only 7.5 per cent of trade invoicing in India. This is despite EU contributing about 27 per cent of total exports and 30 per cent of total imports and Germany, the largest trading partner. "The phasing out will not take place overnight but by January 2002, the RBI will not hold any DM in its kitty," sources said.

On the legal front, the Reserve Bank has advised the centre that the euro as a currency will have to be inducted into the Foreign Exchnage Regulation Act (Fera) after January 1, 1999.

The RBI had set up a working group headed by former executive director V Subramanyam to assess the impact of euro on the working of commercial banks in India as well as trade-related activites. The report, submitted on October 31, formsthe backdrop to the RBI response to the emergence of the new currency.

Kicking off its agenda to tackle the new currency, the RBI has already directed banks that FCNR deposits can be accepted in euro although banks are allowed to accept DM deposits as well till December 31, 2001. According to the RBI, the introduction of the single currency unit will provide an opportunity for raising larger FCNR deposits and there will be no currency risk among the EMU currencies.

On the cash managament front, the RBI has advised banks to avail of the pooling and sweeping services that the euro will offer. Pooling enables the account holder's credit and debit balances in euro and national currency unit (NCU) to be notionally offset for the purposes of calculating interest to maximise liquidity without transfering the funds. Sweeping, on the other hand, involves transfering funds between different accounts denominated in euro and NCU into a single euro account so as to give the account holder more flexiblity in handlingcash flows.

The RBI has also directed banks to fix the rates on FCNR euro deposits to Euro-Libor instead of Euribor. While Euro-Libor will be a fixed spot (the British Bankers' Association will replace the current Libor with the Euro-Libor of January 1, 1999), Euribor will be the parallel reference rate which will base its calculation on a wide pool of more than 50 banks compared with 16 banks for Libor. Both Banque de France and Budesbank are strong proponents of Euribor while BBA supports the Euro-Libor.

In case of existing floating rate FCNR deposits, banks are allowed to calculate the spreads over the relevant euro Libor rate at the next interest fixing date. For new deposits -- both floating and fixed -- interest rates should be linked to Euro Libor, the RBI has said.

Foreign currency loans in DM can continue in that currency till December 31, 2001. On January 1, 2002, it will automatically get converted into euro. While there will not be any change in interest rates on fixed rate loans tillmaturity, floating rate loans will have to linked to Euro-Libor. In case of new loans, the refernce rate could be either Euro-Libor of Euribor, the RBI has said.