Forex inflows may slow down and banks may be deprived of cheap funds if the government accepts Reserve Bank of India's suggestion to tax non-resident Indian deposits, bankers warned on Wednesday.

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"As Reserve Bank capped interest rates on NRI deposits at one per cent above LIBOR, the only attraction for the expatriates is to put their money in such deposits that were enjoying tax exemptions till now," a top official of a public sector bank told PTI.

"If that (tax sop) is taken away, there will not only be a sizeable impact on the banking sector but also foreign exchange inflows may slow down," he cautioned.

Stressing that there are dangers of excessive short-term debt in fast-changing global scenario, an RBI internal group had recommended that interest income from NRI deposits, growing at about 12 per cent, may be taxed like domestic deposits consistent with current account convertibility.

NRI deposits stood at $28.53 billion till December 2003.

With uncertainty over global crude prices in the wake of recent attacks in Saudi Arabia and a choppy stock market in India, there is always a need for "extra-cushioning" for forex reserves, now at $118 billion, and this could come only from NRI deposits, chairman of a public sector bank said.

The move to access cheap fund comes in the wake of heightened commitment towards agriculture, a promise made by the UPA goverment in its Common Minimum Programme.

A market analyst, however, pointed out another aspect of RBI's suggestion on taxation, saying it was an admission of the rising short-term debts, which otherwise, had been denied by the previous National Democratic Alliance government.

In this context, banking sources said they had informed RBI from "time-to-time" on rising NRI term deposits, which were short-term in nature, but "nothing was done in this regard possibly not to derail the shining campaign."

The RBI group had noted that in the recent past, there have been attempts to reduce India's external debt by prepayment but NRI deposits have been a major source of increase in external debt during this period.

NRI deposit schemes were given tax benefits in the past to attract foreign exchange funds in the times of pressing Balance of Payments requirements.

However, over the years, NRI deposit inflows had become much larger and there is no need to give such benefits on these deposits in light of the comfortable forex reserves.