RBI’s Abrupt FCNR(B) Exit Sends Conflicting Signals to Rupee Markets

The US–Iran crisis has tested, and continues to test, the rupee, prompting the RBI in June to draw in foreign currency inflows through an FCNR(B) window, echoing the 2013 exercise. RBI data show that the window had attracted $52.3 billion by August 13, almost twice the amount raised in 2013. Yet, after ruling out an early closure barely two weeks earlier, the RBI Governor Sanjay Malhotra surprised banks by announcing that the window would close on August 31, a month earlier than originally planned.

The sudden reversal poses challenges for the rupee, India’s external account, domestic bond markets, and bank balance sheets. Total inflows may fall $10 billion–$15 billion short of expectations, even if NRIs rush to park funds during the final fortnight. The 2026–27 balance of payments surplus could therefore be lower by a similar amount.

The rupee weakened 0.2% to ₹95.61 against the dollar immediately after the surprise announcement. Banking-system liquidity improved from a deficit at the start of June to a surplus of around ₹3.5 trillion, and will likely stabilise rather than rise further towards the expected ₹4.5 trillion.

The reversal also wrong-footed India’s bond market. After the RBI launched the window, banks swapped the dollar funds with the RBI and deployed the resulting rupee liquidity in short-tenor government securities, compressing two-year yields from 6.32% when the window was announced on June 5 to a low of 5.90% by month-end, and keeping them near 6.10% in July.

Traders piled into a profitable curve-steepening trade, betting that short-tenor yields would fall further relative to 10- and 30-year yields. However, the trades were quickly unwound after the early-closure announcement, with the two-year yield jumping 9 basis points to 6.19% immediately.

Early Close
Why, then, did the RBI close the window early?

First, the window may have achieved the dollar-inflow target the RBI set for itself. The RBI’s foreign exchange reserves have risen significantly over the past month to $708 billion because of FCNR(B) inflows, despite the central bank using reserves to intervene in the market, a position with which it may be comfortable.

Additional dollar inflows could create excess liquidity in the banking system, push effective interest rates lower, and potentially fuel leveraged spending and demand-led inflation. FCNR(B) deposits are also costly for the RBI because it bears the hedging cost on banks’ future dollar liabilities to NRI depositors under the scheme.

SBI Research estimates the hedging cost at around $10 billion and suggests it is small compared with more than $700 billion in foreign exchange reserves. On a simple ratio, however, the RBI would be spending $10 billion to raise $50 billion–60 billion, equivalent to roughly 17–20% of inflows, a substantial quasi-interest cost.

Beyond these obvious explanations, two less visible factors may also account for the early exit. The first is that the RBI may have wanted to limit moral hazard, the tendency for banks to increase risk in their lending portfolios backed by subsidised dollar deposits, while the RBI bears the hedging cost.

The second is competitive asymmetry. The FCNR(B) window puts smaller banks at a disadvantage relative to larger lenders, which are better able to attract NRI deposits, a valuable source of funding to expand credit and market share when banks are struggling to raise domestic deposits. Representations from smaller banks may therefore have influenced the early closure.

Finally, the RBI may have wanted to signal comfort with its foreign exchange reserves and balance-of-payments position by unexpectedly closing the window early. If so, the market read the signal differently, and the rupee weakened instead.

Rupee Puzzle
The 2026 FCNR(B) experience stands in sharp contrast to 2013. Despite inflows of roughly $50 billion, about twice the scale of the earlier episode, the rupee has barely moved, compared with appreciation of more than 7% after the 2013 scheme.

This divergence illustrates an intuitive yet frequently overlooked market principle: net positive demand for an asset does not, by itself, guarantee price gains. What matters is who is buying.

For the rupee, price discovery occurs largely in the offshore market and is driven by hedge funds and macro traders, a risk-tolerant cohort that acts as the marginal price-setter. With this cohort remaining net short on the rupee, citing lingering US–Iran tensions and India’s limited fiscal capacity to absorb a prolonged external shock, structural demand from risk-averse NRI depositors, however large in aggregate, has proved insufficient to move the needle on the exchange rate.

The early closure may therefore signal comfort with the reserve buffer, but it does not resolve the more important question of why record inflows have delivered so little support to the currency.