India's dollar deposit miracle has an expiry date

THE RESERVE BANK of India has pulled off a textbook rescue of its foreign-exchange reserves. In little more than two months it has lured more than $36.7 billion of dollars back into the country by asking non-resident Indians to park their savings in Indian banks at above-market rates. The scheme, known as FCNR(B), was launched on June 8th with a September 30th deadline. On Wednesday the central bank's governor, Sanjay Malhotra, said there was no intention to close it early. It is working so well, he implied, that it should be allowed to run its course.

Mr Malhotra's satisfaction is understandable. India's forex reserves had been bleeding through the first half of the year. The war between the United States and Iran, which began in late February, sent oil prices surging and triggered capital flight. Net foreign portfolio investment outflows reached $16.5bn in the 2025-26 fiscal year, reversing two years of inflows, the RBI's own annual report showed. By late May reserves had fallen to $681bn, their lowest level in more than a year. The rupee touched a record 96.96 to the dollar.

The FCNR(B) window changed all that. By offering banks a zero-cost dollar-rupee swap facility, the RBI absorbed the hedging cost that would otherwise have narrowed the returns Indian banks could offer overseas depositors. Banks were then freed from interest-rate caps and began offering up to 7% on three- to five-year dollar deposits - well above the roughly 4.2% yield on comparable U.S. Treasury notes. The response was brisk. Outstanding FCNR(B) deposits nearly doubled, from $32.6bn in early June to $60.6bn by the end of July. Headline reserves rose to $692.9bn as of July 31st, their biggest weekly jump in six months, according to Reuters. The rupee rebounded to 95.38 to the dollar that same week.

The arithmetic is straightforward, but it conceals a structural problem. The scheme is not attracting genuinely new foreign investment. It is paying the country's diaspora to lend dollars to their home country at a subsidised rate. The RBI does not actually need the deposits for its own balance-sheet. It swaps them out straight away, using the incoming dollars to build its foreign-currency asset pile and investing the excess in overseas securities. Mr Malhotra told The Hindu Businessline that the central bank has a "foolproof system" to insulate itself from risk. What the RBI really wants is the appearance of durable inflow, a larger reserve number, and room to sell dollars into the market without looking desperate.

To be sure, the logic is not dishonest. India faces a genuine external shock. The energy spike from the Middle East conflict widens the current-account deficit. Capital outflows in the "other capital" category - advance import payments, unrepatriated export receipts, funds parked overseas - reached $22.6bn in 2025-26, up from $7.4bn the prior year. The central bank had good reason to shore up reserves before the rupee's depreciation became self-reinforcing. And the RBI is careful to emphasise that the deposits carry a mandatory one-year lock-in, which is supposed to distinguish them from hot money.

Yet the deeper problem is what happens after September 30th. At that point the subsidised window closes. Banks can no longer offer above-market rates on fresh deposits, because the RBI will no longer absorb the swap cost. The $36.7bn of new FCNR(B) deposits raised under the special scheme will eventually mature, three to five years from now, and the RBI will need to either roll them over at market rates or let them drain away. If the dollar remains strong and geopolitical uncertainty persists, those dollars will be sorely missed. If the situation normalises, the scheme's excess will look like an expensive vanity project.

The last time the RBI ran a version of this scheme was in 2013, during the Federal Reserve's "taper tantrum". It then raised about $34bn in a matter of weeks, by much the same mechanism. The reserves rebuilt. The rupee stabilised. But the underlying vulnerabilities - India's dependence on energy imports, its susceptibility to shifts in U.S. monetary policy, the structural tendency of foreign investors to treat India as a risk-on portfolio satellite - remained untouched. When the next shock came, the country was no better prepared than before.

The incentive structure this time is even more disquieting. The swap facility that makes the scheme work is effectively a transfer of risk from private depositors to the public balance-sheet. The RBI gains dollars and loses rupee-denominated swap obligations. That is manageable when the rupee is stable. It becomes a problem if the currency weakens further while the book of swaps is still open. The central bank has the reserves to absorb the hit, but only if the shock does not exceed the very kind of crisis the scheme was designed to prevent.

What the RBI should be doing with the breathing room this scheme provides is not celebrating the headline reserve number. It should be pressing the government to reduce the structural drivers of dollar demand. India's import bill is disproportionately weighted towards energy, which means every oil-price spike translates into a reserve drain. The share of services exports, remittances and merchandise trade that could offset the energy deficit needs to grow faster than it has. A stronger international role for the rupee in trade settlement would help, but that is a project measured in decades, not months.

The FCNR(B) scheme is a clever bit of financial engineering. It has bought India time and reassured markets that the central bank is not helpless. It is not, however, a solution. Reserves rebuilt by subsidy are not the same as reserves earned by competitive advantage. The trick will be to use the pause for something more permanent, before the window closes and the clock starts ticking again.