RBI's $127 Billion FCNR Inflows Boost Forex Reserves, but Create New Liquidity Challenge
The Reserve Bank of India (RBI) entered the summer of 2026 focused on supporting the rupee amid the uncertainty caused by the West Asia conflict. Three months later, the central bank has accumulated a record foreign exchange reserve position, but the sharp increase in foreign currency inflows has created two new challenges.
The first is the need to manage a substantial rise in domestic liquidity. The second is the possibility of significant foreign currency outflows in the future as deposits raised through the RBI’s special concessional swap facility mature over the next three to five years.
The special window launched by the RBI in June attracted around $127 billion through Foreign Currency Non-Resident (Bank), or FCNR(B), deposits. Another $5.26 billion came through Overseas Foreign Currency Borrowings (OFCBs), while External Commercial Borrowings (ECBs) contributed $3.89 billion as of the end of August.
These inflows helped push India’s foreign exchange reserves to a record $785.7 billion by September 4.
Why the RBI Is Dealing With Excess LiquidityUnder the swap arrangement, banks exchange the foreign currency they raise through these deposits with the RBI for rupees. This increases the amount of rupee liquidity available in the banking system.
As a result, surplus liquidity climbed to more than ₹11 lakh crore in the first week of September, prompting the RBI to increase its efforts to absorb excess funds from the financial system.
Banks offered interest rates of around 6-7% on FCNR(B) deposits under the special window, compared with the 3-4% rates that were generally available on such deposits earlier. Since these deposits have maturities ranging from three to five years, the RBI could eventually face substantial dollar outflows when depositors redeem them.
The central bank had introduced a similar FCNR(B) swap facility in 2013 when the rupee was under intense pressure after the US Federal Reserve indicated that it could begin reducing its bond-buying programme. That facility helped Indian banks mobilise around $26 billion in foreign currency deposits at a time when external financing conditions had deteriorated sharply.
Economists and market experts remain divided over whether the latest FCNR(B) initiative was necessary.
Prasanna Tantri, Associate Professor of Finance at the Indian School of Business, argued that the 2013 situation was significantly different. He noted that the rupee had fallen by around 20%, the current account deficit was close to 5% and investor confidence was weak.
According to Tantri, there was no comparable foreign exchange emergency this time. He said the RBI could instead have considered conventional measures such as higher interest rates, pointing to Bank Indonesia, which raised rates by 100 basis points during May-June 2026.
Abheek Barua, visiting professor at Ashoka University and former chief economist at HDFC Bank, has a different view. He said large foreign currency inflows can help stabilise the rupee and suggested that the currency could have moved towards the 100-per-dollar level without the FCNR(B) initiative.
How the RBI’s Special FCNR(B) Window WorkedThe RBI introduced the special FCNR(B) facility in June against the backdrop of renewed US-Iran tensions, higher crude oil prices, a rising import bill and a sharp decline in the rupee.
Foreign portfolio investors were also selling heavily in Indian markets. The rupee had fallen to a record low of 96.96 against the US dollar on May 20.
Under the concessional swap arrangement, Indian banks—including private-sector, public-sector and foreign banks—could mobilise FCNR(B) deposits in freely convertible currencies such as the US dollar, euro and British pound. However, the RBI’s rupee swap facility was available only against US dollars.
Once the deposits mature after three to five years, banks can return to the RBI and exchange the rupee funds for foreign currency.
The RBI also agreed to absorb the hedging cost associated with the deposits, making the facility more attractive to banks. In addition, banks raising FCNR(B) deposits were allowed to provide loans against those deposits to non-residents.
The response was considerably stronger than expected. The RBI closed the special FCNR(B) window on August 31, a month earlier than the originally scheduled September 30 deadline. The special facilities for OFCB and ECB inflows, however, will remain available until the end of December 2026.
Finance Ministry data presented in the Lok Sabha on August 3 showed that large private-sector banks were among the leading mobilisers of FCNR(B) deposits. Foreign banks, despite having relatively smaller domestic deposit bases, also attracted significant amounts.
HSBC’s outstanding FCNR(B) deposits increased from $120.3 million on June 5, 2026, to $6.26 billion by July 30. Standard Chartered Bank had $1.86 billion in outstanding FCNR(B) deposits as of July 30.
The final official data covering all banks at the end of August, when the special window closed, had not yet been released.
According to CareEdge Ratings, some foreign banks were able to attract deposits by offering leverage of 19-29 times, while selected private banks offered leverage of 12-15 times. Banks generally offer leverage of around nine times.
With leveraged FCNR(B) deposits, an investor contributes part of the funds and borrows additional foreign currency against the deposit through the bank or an affiliated overseas lender. That additional borrowing is also invested in FCNR(B) deposits, resulting in a much larger deposit base.
The inflows helped strengthen India’s foreign exchange reserves and also supported the rupee to some extent. By early September, the currency had recovered to above 94.5 per US dollar from 95.74 in early June.
However, the recovery has been less pronounced than in 2013, when the rupee gained around 8% following FCNR(B) inflows. More recently, the currency again came under pressure and briefly crossed the 96-per-dollar level during intraday trading on September 17 amid renewed tensions in West Asia.
Radhika Rao, senior economist and executive director at DBS Bank, said the record accumulation of foreign exchange reserves gives policymakers a larger buffer against currency volatility, commodity price shocks and changes in global risk sentiment.
Surplus Liquidity Puts RBI’s Policy Tools in FocusThe immediate issue created by the large FCNR(B) inflows is the sharp increase in liquidity.
For banks, the additional funds are not necessarily negative. The inflows can reduce competition for domestic deposits and lower banks’ reliance on expensive wholesale funding. They could also support lending if banks deploy the additional liquidity.
For the RBI, however, the impact on short-term interest rates and monetary-policy transmission is more complicated.
Retail inflation rose to 4.82% in August from 4.45% in July, remaining above the RBI’s 4% target for the third consecutive month. Wholesale price index-based inflation also reached 9.92% in August, marking the fourth consecutive month in which it remained close to 10%.
Concerns over food prices have also increased amid a deficient monsoon. Higher crude oil prices could add further pressure to inflation.
The combination of rising inflation and GDP growth of 7.8% during April-June has led some economists to expect a possible interest-rate increase at the RBI’s October monetary policy meeting.
Dhananjay Sinha, CEO and co-head of institutional equities at Systematix Group, said the RBI’s 5.25% policy rate could increasingly appear inconsistent with the inflation trend. He expects the central bank to move towards a meaningfully positive real interest-rate environment, with the repo rate closer to 6.5%.
At the same time, high system-wide liquidity could push short-term market rates lower, creating a disconnect between liquidity conditions and the broader monetary-policy stance. Some experts are also concerned that excess liquidity could encourage faster lending during the festive season, potentially adding to inflationary pressures.
Sinha said the $127 billion forex buffer created through the FCNR(B) programme could help finance the trade deficit and support financial conditions, but the resulting liquidity surplus could make inflation management more difficult.
Prasanna Tantri of ISB also raised concerns about the ability of banks to deploy such a large amount of additional liquidity given the limited lending opportunities currently available.
Bank executives have offered differing assessments. Axis Bank chief executive Amitabh Chaudhary has warned that the liquidity increase could result in unusually high lending. State Bank of India Chairman C.S. Setty, meanwhile, said the surplus liquidity should be absorbed over the next three to four months and urged banks to remain responsible in their lending practices.
Devang Rajkotia, associate vice president at Moody’s Ratings, does not expect banks to significantly accelerate lending. Excluding deposit-backed lending linked to FCNR(B), he continues to expect credit growth of 13-15%, supported by domestic demand and investment activity.
The RBI has already begun using several tools to absorb the excess liquidity. On September 11, it announced government bond sales worth Rs 1 lakh crore through three OMO auctions. On September 17, it absorbed another Rs 2.4 lakh crore from banks through variable rate reverse repo (VRRR) auctions.
VRRR is a mechanism through which the RBI absorbs surplus funds from banks for a specified period.
Rajkotia expects VRRR auctions to remain an important instrument for managing liquidity. If the surplus persists, the RBI could also make greater use of longer-duration VRRR operations, the Standing Deposit Facility (SDF) and selected open market sales.
He said the RBI’s focus would be on keeping short-term market rates aligned with the policy rate and ensuring that monetary policy remains effective despite temporary liquidity surpluses.
FCNR(B) Maturities Could Create a Future Dollar OutflowAnother issue for the RBI is the eventual maturity of the FCNR(B) deposits.
Governor Sanjay Malhotra recently said in a television interview that nearly half of the deposits raised through the special facility have a five-year maturity, while around 42% have maturities of three years to less than four years.
As these deposits begin to mature, depositors could convert their funds back into foreign currency. This could increase demand for dollars and put pressure on the rupee, particularly if global economic and geopolitical conditions remain difficult.
Murthy Nagarajan, Head of Fixed Income at Tata Asset Management, said higher interest rates in developed economies could put pressure on the Indian currency. He also said the RBI may need to buy dollars in the coming years to reduce its forward liabilities, which will become due from 2029 onwards.
Nagarajan said the central bank would have to balance economic growth, keeping CPI inflation around 4% or lower, and maintaining macroeconomic stability. He added that a positive real interest rate of around 1.5% could be important for attracting both FDI and FPI flows and supporting currency stability.
The RBI will also have to account for hedging costs associated with the FCNR(B) deposits. These costs, or forward premiums, are estimated at around 2.5-3.5% a year.
Banks generally hedge the currency risk associated with FCNR(B) deposits through RBI buy/sell foreign exchange swap facilities. This arrangement shifts the currency risk to the central bank and protects banks from potential losses caused by rupee depreciation.
Soumya Kanti Ghosh, Member of the 16th Finance Commission and Group Chief Economic Adviser at State Bank of India, is less concerned about the RBI’s hedging costs.
Ghosh estimates that if the RBI invested $100 billion in globally investible assets at a 4% yield over five years, it could generate around $20 billion in returns. He estimates that this could offset approximately $15 billion in hedging costs and potentially leave around $5 billion, or about Rs 50,000 crore, in additional profitability for the RBI’s balance sheet at current estimates.
However, the RBI has clarified that its coverage will apply only to the principal amount of the deposits and not the interest component. Banks will therefore have to bear the hedging cost on the interest portion. Industry watchers estimate that this could increase the effective cost of raising FCNR(B) deposits by around 20 basis points.
Abheek Barua said the eventual outflows would present a challenge three years from now, but argued that short-term currency stability was the immediate priority.
Moody’s Rajkotia said the RBI still has several years to prepare for the maturities and noted that the experience of 2013 showed that large FCNR(B) maturities could be handled without major disruption to financial markets.
Radhika Rao of DBS Bank said part of India’s existing foreign exchange reserves could potentially be earmarked against these future liabilities. According to her, this could help address concerns that deposit maturities or debt repayments might lead to a sharp rise in dollar demand and put pressure on the foreign exchange market.
Tantri of ISB, however, questioned whether conditions several years from now can be predicted with certainty. He pointed to the 2013 experience, when FCNR(B) deposits were raised and subsequently repaid in 2016 without a major disruption, but noted that future geopolitical conditions cannot be guaranteed.
The RBI’s challenge, therefore, extends beyond managing today’s liquidity surplus. It also involves preparing for the eventual maturity of the large foreign currency deposits while balancing exchange-rate stability, inflation, interest rates and broader financial conditions.
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