Why experts are divided over whether the latest FCNR(B) move was warranted

India’s central bank went into the summer of 2026 trying to shore up the rupee amid turmoil triggered by the West Asia war. Three months later, the Reserve Bank of India (RBI) has built a record foreign exchange war chest that has, in turn, created two new concerns. One, there is a surge in domestic liquidity. And two, a large pool of foreign currency raised through a special concessional swap window may flow out three-five years down the line.

The special window opened by the RBI in June to attract foreign currency has brought in a much larger-than-expected $127 billion through foreign currency non-resident (bank) or FCNR(B) deposits. Additionally, $5.26 billion has come in through overseas foreign currency borrowings (OFCBs) and $3.89 billion from external commercial borrowings (ECBs) as of end-August, helping push foreign exchange reserves to a record $785.7 billion by September 4.

However, under a swap arrangement, banks exchange the foreign currency deposits raised for rupees from the RBI, adding to rupee liquidity in the banking system. As a result, surplus liquidity has since surged and was more than Rs 11 lakh crore in the first week of September, forcing the central bank to step up efforts to absorb it.

Banks offered interest rates of 6-7% on FCNR (B) deposits during the special window, compared to the 3-4% interest that would be typically offered on such deposits earlier. These deposits will mature in three to five years, potentially creating a large outflow of dollars at a time when global and domestic conditions could be very different.

The RBI had used a similar swap window in 2013, when the rupee was under severe pressure after the US Federal Reserve signalled that it could begin tapering its bond-buying programme. The FCNR(B) swap window then helped banks mobilise about $26 billion of foreign-currency deposits, giving the central bank access to dollars when the country was facing a sharp deterioration in external financing conditions.

Experts are divided over whether the latest FCNR(B) move was warranted at this point.

Prasanna Tantri, Associate Professor, Finance, Indian School of Business, says the FCNR(B) move made sense in 2013, when the currency collapsed around 20%, current account deficit was close to 5%, and there was a lack of confidence in the country. There was no reason for such an emergency measure this time, he says.

“There was no forex issue this time. Even if you were to take out the forward short positions of RBI, your forex reserves would still be $500-600 billion (in June when the window was opened),” he says. “Other than the rupee probably touching 100 to the US dollar, I don’t see any calamity that could have happened. So, there was absolutely no reason for such an emergency measure this time around.” He says the RBI could have taken a more common measure like raising interest rates, which some other countries used to stabilise the currency. Bank Indonesia, for instance, raised its interest rates by 100 basis points over May-June 2026.

On the other hand, noting that lumpy inflows can help stabilise the rupee, Abheek Barua, visiting professor at Ashoka University and former chief economist at HDFC Bank, says the rupee may have moved to the 100 level but for the FCNR(B) move.

“The RBI move (special swap window) helped stabilise the rupee at a time there was so much pressure on the rupee and capital inflows were seen to be a problem,” says Barua.

RBI’S FCNR(B) MOVE

In June, when RBI announced the FCNR(B) scheme, it came in the backdrop of resumption of the US-Iran war, surging crude oil prices, rise in India’s import bill, and the rapid fall in the rupee against the US dollar. Foreign portfolio investors (FPIs) were also heavily selling in the Indian market, adding to the pressure on the rupee, which slumped to a record low of 96.96 against the greenback on May 20.

Under the special concessional swap window, banks in India—including private, state-owned and foreign banks—could raise FCNR (B) deposits in any freely convertible foreign currency like US dollars, euro and British pounds, but the swap facility with the RBI for rupees was only available in US dollars.

When the deposits would mature in three to five years, banks could go back to the RBI and exchange the rupees back for foreign currencies.

The RBI also agreed to bear the hedging cost (what a bank pays to shield itself from currency fluctuations), making it more attractive for banks to mobilise these deposits. Further, the central bank also allowed the banks mobilising FCNR (B) deposits to lend against it to non-residents.

The move was so successful that the RBI closed the special window a month early on August 31, 2026, against the earlier planned September 30. The special windows for OFCB and ECB, however, will remain open until the end of December 2026.

Interestingly, data released by the finance ministry in the Lok Sabha on August 3 showed that while large private sector banks led in FCNR (B) deposit mobilisation, foreign lenders, despite their relatively small domestic deposit franchises, also garnered a good chunk of the FCNR (B) deposits.

HSBC’s FCNR (B) outstanding rose from $120.3 million on June 5, 2026, to $6.26 billion on July 30. Standard Chartered Bank’s outstanding FCNR (B) deposits stood at $1.86 billion as of July 30. Notably, the final official data of all banks at the end of August, when the window closed, hasn’t been released yet.

Foreign banks managed to attract FCNR (B) deposits aided by offering leverage of as high as 19-29 times, according to CareEdge Ratings, while select private banks offered 12-15 times leverage. Generally, banks offer nine times leverage.

In leveraged FCNR (B) deposits, an investor contributes a portion of the deposit from own funds. The investor borrows additional foreign currency against the deposit through the bank or an affiliated overseas lender, which is also invested in FCNR (B), creating a significantly larger deposit base.

Apart from boosting forex reserves, the deposits also partially contributed to the recovery of the rupee. By early September, the Indian currency had risen to above 94.5 against the US dollar, compared to 95.74 in early June.

To be sure, comparatively, the rupee had recovered a sharper 8% in 2013 on the back of FCNR(B) flows. But with the currency currently falling again recently—it breached the 96-to-the-dollar mark intraday on September 17—amid reescalation of the West Asia conflict, economists say the record reserves would come in handy for the RBI to intervene in the forex market.

“The record build-up in foreign reserves has changed the policy calculus, providing policymakers a substantial buffer against forex volatility, commodity price shocks, and swings in global risk sentiments,” says Radhika Rao, senior economist and executive director at DBS Bank, adding that the economy is heading into a period of greater uncertainty with considerably more policy flexibility than in earlier cycles.

LIQUIDITY SURGE

The immediate challenge is the excess liquidity, which is not necessarily a bad thing for banks. Experts say the inflow of FCNR(B) deposits will reduce pressure on lenders to compete for domestic deposits and could lower their dependence on high-cost wholesale funding. It could also support credit growth if banks choose to deploy the additional liquidity.

The concern for the RBI, however, is what this does to short-term interest rates and monetary-policy transmission. With inflation beginning to firm up, the central bank has little incentive to allow excess liquidity to fuel a fresh credit and demand cycle.

Retail inflation rose to 4.82% in August compared with 4.45% in July, staying above the RBI’s targeted 4% for the third consecutive month. WPI (wholesale price index)-based inflation, meanwhile, hit 9.92% in August, the fourth straight month that it has been close to 10%. With a deficient monsoon, there is a worry food prices will rise, which coupled with the surging crude oil prices will put upward pressure on inflation.

The combination of rising inflation and firm GDP growth (7.8% in April-June) has strengthened the case for the RBI to raise interest rates in the next monetary policy committee (MPC) meeting in October, according to some economists. Recent rate hikes by major central banks included one by the US Federal Reserve on September 16, its first in three years, and by the Bank of Japan on September 18, 2026, reaching its highest level in 31 years.

“The RBI’s current position of keeping the rate at 5.25% as long as possible looks increasingly out of step with the inflation trajectory,” says Dhananjay Sinha, CEO and co-head, institutional equities, Systematix Group, adding that persistently high WPI and CPI point to growing discomfort with a negative real rates scenario. “We expect a shift towards a meaningfully positive real rate, with the repo nearer 6.5%, rather than continued accommodation,” said Sinha.

In such a scenario, high system-wide liquidity, which will drive short-term rates lower, sends confusing signals to the market. Moreover, some also worry that excess liquidity could again lead to an exuberance in lending during the festive season, which may compound inflationary concerns.

“The $127 billion forex buffer raised through the FCNR(B) scheme should help fund the trade deficit and support financial conditions, but the surplus liquidity it has created risks adding to inflation — leaving the RBI to juggle sterilisation, external stability, and price control even as it’s pushed towards a hike sooner rather than later,” says Sinha.

ISB’s Tantri says while financial stability has been one of the biggest achievements of the current government, the $127-odd billion in the system could have an adverse impact given there aren’t that many opportunities right now for banks to lend so much money.

Top bankers remain divided on how this will play out. Axis Bank’s Chief Executive Amitabh Chaudhary recently warned that the liquidity surge could lead to abnormal lending. On the other hand, C.S. Setty, chairman of State Bank of India, said the liquidity would get absorbed over the next three to four months. He hoped “everybody will be more responsible in lending”.

Devang Rajkotia, associate vice president at Moody’s Ratings, doesn’t expect banks to materially accelerate lending and—excluding deposit-backed lending linked to FCNR (B)—he still expects 13-15% credit growth, supported by domestic demand and investment activity.

The excessive liquidity has brought RBI’s money management tools into play. On September 11, it announced sovereign bond sales through the open market to mop up Rs 1 lakh crore in three tranches. On September 17, the central bank absorbed another Rs 2.4 lakh crore from the banking sector through variable rate reverse repo auctions (VRRR). The reverse repo rate is the interest rate the central bank pays commercial banks when it borrows money from them.

Rajkotia says VRRR auctions are likely to remain the RBI’s primary tool for absorbing liquidity, and a sustained surplus could also see greater use of longer-tenor VRRRs, the standing deposit facility (SDF, where banks deposit their money with the RBI without any collateral), and selective open market sales.

“The RBI’s focus will be on keeping short-term market rates aligned with the policy rate and ensuring monetary policy remains effective, rather than temporary excess liquidity,” he said.

REDEMPTION CHALLENGE

The RBI will also be mindful that the FCNR (B) deposits will mature in three to five years and then the forex will flow out. Governor Sanjay Malhotra said in a television interview recently that nearly half the deposits have a five-year tenor, while around 42% are for three-year to less than four-year period.

So, as deposits start maturing in three years and depositors start redeeming, the rupee could come under pressure, more so if external conditions remain unfavourable.

“If high interest rates prevail in developed economies due to geopolitical reasons, we will see pressure on the Indian currency. The RBI may buy dollars in the coming years to reduce its forward liabilities, which will become due from 2029 onwards,” says Murthy Nagarajan, Head – Fixed Income, Tata Asset Management. He feels the RBI has to do a “fine balancing act” of keeping growth high and keeping CPI inflation around 4% or below, without compromising on macro-economic stability. “Maintaining a positive real interest rate of 1.5% would be important to attract capital flows—both FDI and FPI—which should stabilise the currency at current levels,” he says.

There is also the hedging cost (forward premium) that the RBI will incur that typically banks pay to guard themselves from forex losses. This is estimated to be 2.5-3.5% per year.

Banks typically hedge the currency risk on FCNR (B) deposits by using buy/sell foreign exchange swap facilities of the RBI. Any risk of currency depreciation will shift to the central bank, in turn protecting the banks should the rupee depreciate in the future.

However, Soumya Kanti Ghosh, Member, 16th Finance Commission and Group Chief Economic Adviser, State Bank of India, is not too worried on the hedging costs for the RBI.

Ghosh says RBI’s deployment of, say, $100 billion in globally investible avenues at a yield of, say, 4% over five years should accrue profits of $20 billion, which would offset the outgo on hedging ($15 billion) and actually add some profitability of around $5 billion (about Rs 50,000 crore) to its balance sheet at current estimates.

However, the RBI has also said that it will only cover the principal amount of the deposits and not the interest component. So, banks will have to bear the hedging cost on the interest component, which is expected to increase the effective cost of raising the FCNR (B) by around 20 basis points, say industry watchers.

Economist Barua says the outflows will certainly be a problem three years on, but the current focus should be on short-term stability.

“At certain moments when the rupee market is in a crisis situation, short-term stability matters more than long-term consequences,” he says. “Long-term consequences are there and will have to be managed carefully.”

Rajkotia of Moody’s says RBI has several years to prepare for these outflows and points out that the 2013 FCNR (B) experience suggests that large maturities can be managed without major market disruption.

“A portion of the existing foreign reserve stock could be earmarked against these liabilities, helping to mitigate concerns that deposit maturities or debt repayments could trigger a sharp increase in dollar demand and exert pressure on the forex market down the line,” says Rao of DBS Bank.

But ISB’s Tantri has a different take: “You (raised FCNR (B) deposits) in 2013 and repaid in 2016. Fortunately, nothing happened. But are we sure that in 2030, there will be no geopolitical crisis? So, were we in such a bad situation that we had to take such a risk is the question we have to ask today.”

@TheNachiket