FX Measures Could Attract Up to $75 Billion of Debt Inflows

One of the more notable trends in capital flows into Indian assets has been the divergence between equity and debt flows. Since calendar year 2024, cumulative equity capital outflows have amounted to nearly $48 billion, while debt capital inflows have totalled about $26 billion.

In essence, debt capital has remained patient, rewarding India’s improved fiscal position and its well-established flexible inflation targeting framework. At a time when domestic growth capital remains scarce, it is logical that the government and the Reserve Bank of India have jointly unveiled a comprehensive package of measures aimed at boosting capital inflows through external commercial borrowing concessions, a subsidised FCNR deposit scheme and tax exemptions on government securities investments by foreign portfolio investors.

The objective appears clear: attract durable dollar inflows, ease funding pressures and strengthen the balance of payments.

FCNR Opportunity
The first measure involves incentivising banks to mobilise non-resident deposits with maturities of three to five years until September 30, 2026, with the RBI expected to bear the hedging cost. The proposal resembles the 2013 FCNR scheme, which attracted roughly $26 billion of inflows.

Although the current environment differs materially from 2013 because global interest rates remain significantly higher, the scheme could still attract as much as $50 billion under conservative assumptions if leverage provisions similar to those available in 2013 are permitted.

The existing stock of FCNR deposits stands at roughly $35 billion.

Under one scenario, if the RBI extends a full hedging subsidy to both existing and new FCNR deposits, banks could potentially offer rates close to 6.5%, broadly in line with domestic three-year fixed deposit rates of around 6.75%.

Under a second scenario, if the subsidy applies only to incremental deposits, banks would need to absorb the breakage cost associated with existing FCNR liabilities, limiting deposit rates to around 5.75-6.0%.

Market participants broadly expect most deposits to be raised in the three-year bucket rather than the five-year bucket because of the lock-in feature associated with the product.

The attractiveness of the scheme rises materially if leverage similar to that available in 2013 is permitted.

Consider an illustrative example. An investor places $100 million with an overseas branch of an Indian bank and obtains leverage of nine times. Assuming a borrowing cost of three-year Secured Overnight Financing Rate plus 100 basis points, the funding cost works out to roughly 5%. The entire $1 billion can then be placed in a three-year FCNR deposit yielding 6%.

Over three years, the investor earns approximately $180 million in interest income while paying about $135 million in borrowing costs, resulting in a net gain of $45 million on an initial investment of $100 million. Such returns could prove attractive enough to draw substantial participation.

For every $10 billion mobilised under the scheme, the RBI’s annual hedging cost would be roughly $300 million based on current forward premia of around 3%. If inflows reach $50 billion, the total cost over three years could approach $4.5 billion.

Should FCNR mobilisation reach $50 billion by September 2026, banking system liquidity could increase by roughly ₹4.5 trillion. The eventual liquidity impact may be somewhat lower depending on how the RBI manages its existing forward book, currently estimated by market participants at around $102 billion.

Even so, the implications for certificates of deposit, short-term corporate bonds and government securities in the two-to-three-year segment would likely be positive.

Without leverage, however, inflows may be limited to $5 billion-$10 billion. Most market participants currently view such an outcome as less likely.

Compared with 2013, the global Indian diaspora is larger, wealthier and more geographically diversified. As a result, inflows of $50 billion may represent a reasonable base case under a fully incentivised framework, while an outcome closer to $75 billion-$80 billion cannot be ruled out if no mobilisation cap is imposed before September.

Dollar Pipeline
The second measure relates to external commercial borrowings. The RBI has proposed a concessional swap facility for public sector entities raising foreign currency borrowings until September 2026.

The economics are potentially compelling. With current hedge costs estimated at around 800 basis points for three-year borrowings and roughly 1,600 basis points for five-year borrowings, even a partial subsidy could materially lower effective borrowing costs.

Additional inflows of $25 billion-$30 billion through this route appear feasible if offshore borrowing becomes meaningfully cheaper than domestic issuance.

The third major initiative involves expanding the universe of Fully Accessible Route securities and exempting foreign investors from taxation on government securities investments.

The measure effectively shifts taxation from the destination country to the country of investor origin, allowing investors to trade Indian government securities without facing local tax complications. Such a change could improve the prospects for eventual Euroclear settlement eligibility and enhance India's chances of inclusion in the Bloomberg Global Aggregate Index.

These developments alone could potentially attract another $15 billion-$20 billion of inflows.

Additional measures include increasing investment limits for non-resident Indians and Overseas Citizens of India in listed equities without Securities and Exchange Board of India registration and extending the same facility to all individual persons resident outside India. The RBI has also restored the export proceeds repatriation timeline to nine months, reversing the pandemic-era relaxation that had extended it to 15 months.

Taken together, the government and the RBI have rolled out a timely package aimed at attracting dollar inflows while simultaneously addressing domestic deposit constraints. Increased external commercial borrowings could reduce pressure on domestic bond markets, while higher FCNR deposits could ease funding conditions and lower certificate of deposit yields.

A base-case estimate suggests total inflows of roughly $75 billion across all measures. In a more optimistic scenario, particularly if Bloomberg Global Aggregate Index inclusion and Euroclear settlement eventually materialise, inflows could approach $100 billion.

Such flows would go a long way towards offsetting persistent equity outflows, strengthening foreign exchange reserves and supporting rupee stability. If that happens, the resulting improvement in macro-financial conditions may eventually help restore confidence in Indian equities as well.