Raghuram Rajan’s 2013 playbook: Why the RBI just pulled it out again

As higher oil prices, geopolitical tensions and external-sector pressures threaten to narrow the central bank’s policy options, the RBI has chosen an alternative to interest-rate hikes: attract foreign capital. By reviving FCNR(B) incentives, easing ECB norms and making Indian government bonds attractive to overseas investors, policymakers are seeking to strengthen the balance of payments without compromising growth.

The measures itself are wide-ranging. The RBI announced a special FCNR(B) deposit scheme under which it will absorb hedging costs on fresh deposits mobilized by banks, introduced concessional foreign exchange swap facilities for external commercial borrowings (ECB) by public sector entities, expanded the universe of government securities accessible to foreign investors and eased several restrictions on foreign portfolio investment.

The government complemented these measures by removing withholding and capital gains taxes on government securities held by foreign investors. Taken together, the steps amount to a significant effort since 2013 to mobilize foreign capital and strengthen India’s external balance sheet.

The logic seems straightforward – The inflation risk India is facing today is largely a supply-side problem driven by oil, not excess domestic demand. Raising rates would do little to lower crude prices while risking damage to investment and consumption. Instead, the RBI is attempting to shore up the country’s external finances and preserve policy flexibility, drawing on an approach that proved to be successful during the 2013 taper tantrum under then RBI Governor Raghuram Rajan.

What Exactly Is FCNR(B)?

At the heart of the package is the revival of incentives for FCNR(B) deposits.

FCNR(B), or Foreign Currency Non-Resident (Bank) deposits, are fixed deposits that Indian banks offer to Non-Resident Indians (NRIs), Overseas Citizens of India (OCIs) and Persons of Indian Origin. Unlike ordinary NRI deposits, these accounts are maintained in foreign currencies such as US dollars, pound sterling, euros, Japanese yen, Australian dollars and Canadian dollars. The depositor therefore bears no rupee depreciation risk because both principal and interest are repaid in the original foreign currency. Interest income is also exempt from tax in India.

In simple terms, an NRI living in New York can place dollars in an FCNR(B) deposit with an Indian bank and receive dollars back at maturity regardless of how the rupee performs during the investment period.

For Indian banks, however, such deposits create currency risk. Banks typically convert those foreign currency deposits into rupees for domestic lending and investment. To protect themselves against exchange-rate fluctuations, they hedge the exposure through the foreign exchange market. That hedge carries a cost, which has become increasingly expensive.

This is where the RBI’s latest move becomes significant.

The central bank has announced that it will absorb the entire hedging cost for fresh three-to-five-year FCNR(B) deposits mobilized until September 30, 2026. Current market estimates suggest this subsidy is worth roughly 3%, making the economics substantially attractive for banks.

Why This Matters

The subsidy effectively allows banks to offer higher interest rates to overseas Indians while preserving their own profitability.

For an NRI investor, the proposition suddenly becomes compelling. Banks are expected to offer deposit rates of around 5.5% – 6%, which compares favorably with US Treasury yields. Because the RBI is absorbing the currency hedge cost, banks can pass much of the benefit to depositors.

For banks, FCNR(B) deposits provide a relatively stable source of foreign currency funding. They also help ease pressure on domestic deposit mobilization at a time when loan growth has consistently outpaced deposit growth.

For the RBI, FCNR(B) deposits provide an efficient mechanism for rebuilding foreign exchange reserves and reducing pressure on the rupee without tightening monetary policy.

The historical precedent is encouraging. During the 2013 taper tantrum, a similar FCNR(B) scheme mobilized roughly US$26 billion through deposits and more than US$34 billion through the broader range of measures.

How Much Capital Could This Potentially Attract?

The estimates are substantial. Some estimates track these overall measures to attract between US$55 billion and US$65 billion of inflows during FY27 and FCNR(B) deposits alone could generate inflows exceeding US$35 billion.

While today’s global interest-rate environment is less favorable than in 2013, when US interest rates were near zero, the RBI’s willingness to absorb the hedge cost has the potential to significantly improve the economics of the trade.

Understanding ECBs: The Other Pillar of the Strategy

The second major element of the RBI measures involves External Commercial Borrowings, commonly known as ECBs.

An ECB is essentially a foreign currency loan raised by an Indian company from overseas lenders. Instead of borrowing from domestic banks, firms can access global capital markets and international financial institutions.

A simple example illustrates the concept. Suppose a public sector company needs funding for infrastructure investment. Rather than borrowing exclusively from Indian banks, it can raise dollar-denominated debt from international investors. Those dollars then flow into India, improving the capital account.

The challenge, again, is currency risk. If the rupee weakens significantly, the borrower faces higher repayment costs.

To address this issue, the RBI has announced a concessional foreign exchange swap facility for ECBs raised by public sector enterprises until September 2026. The final details are still awaited, but the intention is clear: lower hedging costs and encourage more overseas borrowing.

Who Benefits from ECB Liberalisation?

The beneficiaries extend well beyond the borrowing companies.

Public sector enterprises gain access to cheaper funding. Commercial banks experience reduced pressure on their balance sheets because some financing shifts away from domestic credit channels. Corporate borrowers gain greater funding flexibility.

The broader economy benefits because foreign capital supplements domestic savings.

Over the past year, India’s financial system has relied increasingly on bank credit as foreign direct investment, ECBs and corporate bond issuance softened. The new measures could help reverse that trend by reviving non-bank sources of funding.

The Government Bond Market Gets a Boost

The range of measures goes beyond FCNR(B) and ECBs.

The RBI has expanded the Fully Accessible Route (FAR), allowing foreign investors easier access to additional categories of government securities. Restrictions relating to concentration limits and short-term investments have also been eased. Simultaneously, the Government of India has removed withholding tax and capital gains tax on government securities held by foreign portfolio investors.

These changes although may appear technical, their strategic significance is considerable.

One of India’s longstanding ambitions has been inclusion in the Bloomberg Global Aggregate Bond Index. Such inclusion would trigger passive inflows from global bond funds that track the benchmark. The removal of tax and compliance challenges materially strengthens India’s case ahead of future index reviews.

Even if actual index-related inflows arrive only in FY28, markets are likely to react positively well before that date.

Why This Changes the Monetary Policy Equation

An important consequence of these measures is that it gives the RBI policy breathing room.

Rising oil prices and geopolitical uncertainty have increased risks to both inflation and the current account. But stronger capital inflows can offset much of that pressure, supporting the balance of payments, stabilizing the rupee and reducing the need for monetary tightening to defend the currency.

This helps explain why the RBI is likely to remain on pause. The current shock is largely supply-driven, and inflation forecasts remain within the central bank’s tolerance band. In such circumstances, attracting foreign capital may be a more effective response than raising interest rates.

Broadly, these measures are about preserving growth while strengthening India’s external balance sheet. FCNR(B) deposits tap into diaspora savings, ECB incentives encourage overseas borrowing and bond market reforms deepen foreign participation in government securities. Together, these measures create a larger external buffer at a time when global uncertainty is rising.

Buying Time for Economy?

Ultimately, the RBI seems to be buying time… not for the rupee alone, but for the economy.

By attracting foreign capital, policymakers are attempting to bridge what could otherwise become a difficult period marked by elevated oil prices, geopolitical uncertainty and weaker global growth. The inflows help finance a wider current account deficit, support foreign exchange reserves and reduce the need for aggressive monetary tightening.

More importantly, they preserve policy flexibility. Banks gain breathing space as deposit pressures ease. Companies regain access to non-bank funding channels. Government borrowing becomes easier to finance. The rupee faces less depreciation pressure. And the RBI retains the flexibility to focus on growth and inflation rather than defending the currency.

These measures are not a solution to higher oil prices, nor can they eliminate geopolitical risks. What they can do is help prevent a temporary external shock from forcing unnecessary policy tightening at home.

In that sense, FCNR(B) deposits and ECB incentives are not merely instruments for attracting dollars. They are instruments for preserving policy flexibility.

And in an uncertain scenario like this – policy flexibility may be a valuable asset for India . So, the RBI is not buying time for the rupee… It is buying time for growth.

Source: RBI, Bloomberg

Sneha Pandey is Fund Manager for Fixed Income and Multi-Asset Allocation Funds at Quantum AMC

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