FCNR(B): Has RBI bought forex stability at too high a cost?

The Economic Times September 29, 2026

The RBI’s FCNR(B) [Foreign Currency Non-Resident (Bank)] scheme has been widely lauded for attracting $132 billion. But is the amount attracted the right measure of success? A proper assessment should balance the benefits against the costs. When we do so, it is not clear that the benefits of the scheme outweigh the costs.

Without doubt, the scheme has had two positive outcomes. It has bolstered the RBI’s foreign exchange reserves, which rose from USD 682 billion when the scheme was launched on June 5, to USD 785 billion on September 4. It has also helped strengthen the rupee. In May, the rupee appeared headed towards Rs 100 to the dollar. Since then, it has stabilised in a range of Rs 94–96 to the dollar.

Those are clear results. But the deeper question is: what benefits did these outcomes bring to the economy? The answer to this however is less clear. For a start, it is not obvious why the RBI needed more reserves. USD 682 billion was already a sizeable kitty, more than sufficient to finance any prospective balance of payments deficit for this year, or even the next five years.

As for the exchange rate, there is no obvious reason why Rs 95 to the dollar is better for the economy than Rs 100 to the dollar. A more depreciated rupee does hurt importers by making foreign goods and services such as education, more expensive. But it also gives domestic producers some breathing space as they compete with cheap imports from China. Depreciation also helps exporters by making their products cheaper for foreign buyers and helping them find new markets.

In other words, the economic benefits of higher reserves and a stronger rupee are unclear. What about the costs?

First, consider the financial burden. When Indian banks gave dollars to the RBI, the RBI gave them rupees in return, creating more than Rs 10 lakh crore of liquidity. This surplus liquidity is now pushing interbank interest rates below the RBI’s policy rate. That is a problem because with inflation going up, the RBI may need to raise the policy rate in October. But to do so, it will first have to “mop up” the surplus liquidity to bring interbank interest rates back in line with the policy rate. Otherwise, the rate hike will not be effective.

However, absorbing the excess rupee liquidity would be expensive. For example, if the RBI were to sell the banks, Rs 10 lakh crore of 10-year government securities carrying a market interest rate of roughly 7 per cent, the interest cost would be about Rs 70,000 crore a year. This is a sizeable sum.

There are other options. The RBI could ask the government to bear the cost by issuing new government securities, or share part of the cost with the government. The RBI’s additional foreign exchange reserves would generate some income, for example from US Treasury securities, but even after accounting for this, the net cost to the public sector would remain large.

Alternatively, the RBI could make banks bear the cost by raising the Cash Reserve Ratio (CRR). This has two problems. First, banks that have not received the dollar deposits would also be penalised. Second, banks have to pay 6-7 percent interest rate on the NRI deposits but receive nothing on the surplus liquidity deposited with the RBI as a result of any CRR hike. This would undermine banks’ profitability.

The potential costs do not end there. The second problem is that the RBI has assumed considerable exchange rate risk. For every dollar that banks gave the RBI, they received around Rs 95 in return, assuming this to be the prevailing exchange rate. When the deposits mature in roughly five years, the RBI will have to reverse the transaction at the same exchange rate. But what happens if the rupee depreciates in the meantime? Let's say if the exchange rate is Rs 105 when the deposits mature, the RBI would lose Rs 10 for every dollar swapped.

This is only an illustration, since the future exchange rate is unknown. But even a small depreciation could impose a large cost because the amount involved is enormous. Put simply, returning $127 billion after five years could prove costly for the RBI, over and above the cost of absorbing the surplus liquidity. Future dividends from the RBI to the government would consequently suffer.

Perhaps these costs would have been worth incurring if the scheme had been used to buy time to strengthen India’s balance of payments. But no such measures have been announced either to attract more foreign direct investment or more foreign portfolio investment into Indian equities. Partly for this reason, and also because the war in West Asia has intensified, the rupee has begun to fall again.

In summary, the benefits to the economy of the FCNR(B) scheme are unclear, while its costs are significant. In the end, it has left the system weaker than before. This raises a basic question: was the scheme really needed?

The GDP debate, redux

The Business Standard September 15, 2026

The recent GDP data release has rekindled the debate about the credibility of official statistics. It seems odd that while the global economy was facing a severe energy crisis, one of the world’s largest fuel importers was experiencing an economic boom. But just because something seems odd does not mean it did not happen. Also, MoSPI has made several changes to address known problems in GDP estimation. So why are people still questioning the data?

To answer this, we need to understand the problems with the old series, and how MoSPI has addressed them. Two of the most serious problems were the lack of double deflation and inadequate measurement of informal sector output. Let’s consider how these have been addressed.

In the new GDP series, MoSPI seems to have adopted double deflation. This is welcome because, ideally, firms’ nominal value added should be deflated twice: once for output and once for inputs. In the past, MoSPI, unlike G20 countries, deflated the nominal data only once. It did not deflate the value of inputs. This was a problem because changes in input prices, such as large swings in commodity prices would distort real GDP.

In principle, therefore, the shift to double deflation is a good thing. But its impact depends upon how it is implemented. This is where questions arise, because MoSPI has not released enough detail.

For instance, we do not know how widely the double deflation method has been applied. Does it cover all nominal numbers, only the manufacturing sector, or only part of manufacturing? This matters because partial adoption of double deflation could introduce new distortions.

Consider a rise in steel prices. Steel producers will see their margins improve, while steel users will see their margins squeezed. The overall effect on the economy may be neutral. But if double deflation is applied to one group and not the other, the estimated real output will be distorted. If the squeezed margins of steel users are “restored” through double deflation while the higher margins of steel producers are not adjusted downwards, measured output will be overstated.

The choice of deflator is also critical. Most countries use the Producer Price Index (PPI). But for decades, India’s statistical office did not have the prices that factories charge their wholesalers or retailers or data on the thousands of inputs used in production.

This raises the question: what has changed? MoSPI’s own documents say that the input PPI is still under trial. If so, how reliable is it? On the output side, services account for most of the Indian economy, yet the new services PPI covers only seven sub-sectors. What about the remaining services for which no PPI exists?

Next, consider the measurement of informal sector output. MoSPI says this has been addressed through the new survey of unincorporated enterprises (ASUSE) and the Periodic Labour Force Survey (PLFS). But the quarterly ASUSE does not provide value added. So how was informal sector GDP estimated?

Finally, let's step back from the methodological details and look at the big picture painted by the GDP numbers. The problem is that the different parts do not seem to fit together. According to MoSPI, import volumes fell by 1 per cent in the April-June quarter. How, then, did the economy grow by 8 per cent and the import-dependent secondary sector, including manufacturing, grow by 10 per cent in real terms?

The data also show that the value of imports rose by 31 per cent, implying that import prices increased by a staggering 32 per cent. Some of this increase was absorbed by the government, while GST rates were cut (a year ago) and public capex also increased. But these measures were far too small to offset a shock equivalent to around 1.5 per cent of GDP. Someone still had to pay the higher energy bill. This included industry, restaurants and consumers, some of whom had to buy LPG cylinders on the black market. Yet the data suggest that despite this squeeze on incomes, spending increased sharply.

In summary, despite MoSPI’s efforts, it remains difficult to assess whether the problems with the earlier GDP series have been adequately addressed. Part of the problem is transparency. MoSPI has released some information, but it is not enough. The press releases and Frequently Asked Questions (FAQs) provide little detail. The committee reports are more detailed, but it is unclear which recommendations were finally implemented. To restore confidence, MoSPI should release a comprehensive Sources and Methods document, as has always been the practice, with detailed answers to these open questions.

Most important of all is to rekindle the spirit of cooperation. Given the erosion of trust in official GDP data over the years, the best way forward for both stakeholders and MoSPI is to work together to identify the problems and find solutions.

Judging the RBI by the wrong rule

Business Standard August 17, 2026

According to several commentators, the Reserve Bank of India needs to bring about radical changes in its monetary policy conduct. At a minimum, it must change its rate-setting approach. It might even need to abandon inflation targeting altogether. Are these claims valid?

Their argument, in essence, runs like this. Ever since the RBI adopted inflation targeting, real interest rates have stayed far too high, thereby undermining economic growth. This has happened because the RBI follows a flawed approach: it sets rates on the basis of past inflation, even when price pressures are already on the cusp of dissipating.

These are strong claims, and they deserve careful scrutiny. Let’s start with the main one: inflation targeting has biased the RBI toward a tight monetary policy. The data says otherwise.

Since the RBI adopted inflation targeting in 2015, the real rate (nominal repo rate minus headline CPI inflation) has averaged just 1.1 percent (see chart). This is strikingly low for a country growing as rapidly as India. It is also below the neutral rate that the RBI itself estimates at 1.5-2 percent. And it has been too low to achieve the 4 percent inflation target, given that inflation, since 2015, has averaged 5 percent.

Why, then, have commentators been complaining about high real rates? That is because some periods have seen real rates exceed 2 percent, including recently. In 2025-26, the real rate hit 3.5 percent.

Could this have occurred because the RBI's framework focuses only on past inflation, as the commentators claim? Vaishali Garga of the Boston Fed and I analysed the data thoroughly (Garga V. and Sengupta, R, "Do Actions Match Words? Reassessing the Taylor Rule in an Emerging-market Context", Federal Reserve of Boston Working Papers, August 2026). We found that the RBI does consider past inflation when setting the repo rate. But it also puts considerable weight on its inflation forecast-exactly what inflation targeting requires.

The problem, then, is not the framework. It is the accuracy of the forecasts. If the inflation forecast is too high, the real rate will be too high as well, and this is what happened recently. In its April 2025 monetary policy statement, the RBI’s forecast of CPI inflation for 2025-26 was 4 percent. Actual inflation came in at 2 percent. The RBI did not revise its forecast down to that level until the December statement. A wrong forecast, acted on in good faith, produces exactly the outcome commentators point to: real rates that turn out, in hindsight, to have been too tight — or too loose.

Of course, the RBI knows this. As a result, it is extremely pragmatic. In exceptional periods, when the direction of inflation and growth is relatively more obvious, monetary policy can afford to be more aggressive. For example, when Covid hit, it was obvious that aggregate demand would collapse. So, the RBI was comfortable reducing the repo rate to very low levels. But outside such periods, the RBI has been cautious about reacting to new forecasts, keeping the repo rate in a narrow band of 5.25-7 percent, tighter than the range of inflation (2-6.8 percent). This makes sense. When monetary policy is partly forward-looking yet forecasts are error-prone, it is prudent to practise caution.

In summary, it is not correct to assert that the RBI has been biased toward tight monetary policy or that its rate-setting framework is flawed. The real task for the central bank is to improve its inflation forecasts. This is where the debate should move.

Forecasts will never be precise, because the future is always unknown, and it is also true that the global economic environment is unusually uncertain right now. Even so, there are many ways to reduce the size of the RBI's forecast errors.

To start with, India's macroeconomic data has well-documented weaknesses, often giving conflicting signals about how the economy is actually doing. Complicating matters further, whenever the statistical agency introduces a new series for GDP and inflation, it does not release much of a back series, leaving the RBI without the historical data it needs to build accurate models of how the new data behave.

Then, there is the question of household inflation expectations. Existing surveys need better language, because it may not be easy to understand what "inflation rate" means. It is also important to collect data on inflation expectations of firms. Once this is done, deeper research is needed into how inflation expectations actually form and how they feed into long-term contracts. This will also require better data on wages and rents.

A central bank that sets monetary policy based on forecasts is only as credible as its forecasts. That is where the real work needs to go, not in reopening the case for or against the inflation targeting framework itself.

India needs lasting reforms to attract foreign capital, not stopgaps

Business Standard July 28, 2026 (With Alicia Garcia Herrero)

India's biggest economic challenge today is creating enough good jobs. Around 10–12 million young people join the labour force every year, but manufacturing—the sector that should create jobs at this scale—has remained stuck at 15–17 per cent of GDP for two decades. Expanding manufacturing will require higher investment, and domestic savings alone will not be enough to finance it. India needs more foreign direct investment (FDI) to bring in capital, technology as well as jobs. The recently concluded India-EU FTA offers an opportunity to do this. The question is whether India will take it.

The FDI numbers are sobering. While media discourse mostly focuses on the gross numbers, India’s FDI inflows as a share of GDP have fallen to less than 1 per cent, far below the 5.7 per cent average for ASEAN economies such as Vietnam and Malaysia. These countries have emerged as the biggest beneficiaries of the China+1 shift, while India has largely missed out despite being a bigger economy. Moreover, much of the FDI that India does attract goes into services rather than manufacturing, thereby limiting its impact on job creation.

To attract substantial manufacturing FDI, policymakers now have to persuade global firms to choose India for the next phase of their expansion. That will not be easy. It requires addressing the factors that have made India a less attractive investment destination over the past decade.

One important factor has been the growing uncertainty around investment protection. Between 2016 and 2024, India terminated bilateral investment treaties (BITs) with 77 countries, including 22 EU member states, and replaced them with a much narrower 2015 Model BIT. New investments from these countries no longer enjoy the safeguards that BITs typically provide against arbitrary state action, discriminatory treatment, uncompensated expropriation and unpredictable dispute resolution. As a result, foreign investors have less certainty today about investing in India.

In addition, India continues to impose average import tariffs of nearly 16 per cent, well above those in ASEAN economies. Recent bilateral FTAs lower tariffs for a few selected partners but they are a second-best substitute for the broader trade liberalisation that globally integrated manufacturers need. The growing use of Quality Control Orders (QCOs) has further raised costs by restricting access to imported inputs. India's decision to stay out of the WTO's Investment Facilitation for Development Agreement (IFDA) reinforces this perception, signalling caution at a time when global investors are looking for openness. These frictions matter when firms decide where to locate their next factory.

Investment protection deserves fresh thinking. For instance, commercial disputes are contractual matters. If a foreign investor and its Indian partner agree to resolve them through arbitration in Singapore or any another internationally recognised forum, the government should not prevent them from doing so. Giving contracting parties the freedom to choose a credible dispute resolution mechanism would send a strong signal that India is serious about attracting long-term investment.

This is where the recently concluded India-EU FTA becomes important. The EU is the world's largest source of outward investment, accounting for around 40 per cent of global FDI stock, and is already one of India's largest investors. The FTA gives European firms a stronger incentive to manufacture in India. But investment decisions are driven by more than market access. Without credible investment protection, the FTA alone is unlikely to attract the scale of manufacturing FDI that India needs.

Concluding an Investment Protection Agreement (IPA) with the EU should therefore become the next policy priority.

Europe also brings the kind of investment India needs. European manufacturing FDI is typically long term and comes with technology, R & D and jobs rather than just capital. European firms already earn higher returns in India than in the mature US and UK markets, yet their investment in India remains well below its potential.

The timing matters too. European firms are increasingly concluding that China no longer works for them. That capital is looking for a new home, and India, with its scale and young workforce, is the natural candidate to play the role China once did. But the window will not stay open indefinitely. If India hesitates, ASEAN countries or Eastern Europe are likely to absorb the investment instead.

The policy initiatives that India needs to implement are three-fold. First, conclude the IPA that is currently under negotiation with the EU, and do so pragmatically rather than insisting on procedures that trap investors in domestic courts for years. Second, reform the 2015 Model BIT to gear it more toward international norms. Third, lower tariffs on intermediate inputs, progressively dismantle QCOs, and join the WTO’s IFDA. These policy actions would help attract FDI not only from the EU but also from other interested countries.

The India-EU FTA has opened a door. But for European firms to build factories here rather than elsewhere, Indian policymakers need to take the necessary steps, and quickly too, in order to seize yet another China+1 opportunity and make India a more attractive place to invest. That would not only strengthen manufacturing, but also help address India's biggest economic challenge—creating enough productive jobs for its growing workforce.

A central bank that sets monetary policy based on forecasts is only as credible as its forecasts. That is where the real work needs to go, not in reopening the case for or against the inflation targeting framework itself.

Making India attractive to foreign capital: Beyond the RBI's June measures

Business Standard July 14, 2026

Last month, the Reserve Bank of India (RBI) announced a series of measures to support the rupee by encouraging foreign borrowing. So far, they seem to have worked. The rupee has stabilised. But the important question now is whether this stability will last.

The answer depends on whether the problem is temporary or permanent. If it is temporary, the RBI's strategy makes sense. Borrowing can bridge the gap in dollar supply until conditions improve. But if the problem is permanent, borrowing only postpones the adjustment. Eventually, the same problem will return and the country will have to deal with it from a weaker position, since it will have accumulated debts in the meantime.

So, is the problem temporary? Only partly. The war in West Asia has pushed up oil prices, increasing India’s import bill and putting pressure on the balance of payments. But this factor is only a small part of the problem. Even if the war continues for a few more months and oil prices rise back towards $100 a barrel, India's current account deficit should remain within its traditional “safe limit” of 2 per cent of gross domestic product (GDP).

The bigger problem lies in the capital account. For much of the period since the 1991 reforms, India attracted substantial foreign capital. During the investment boom of the mid-2000s, inflows were more than sufficient to finance the current account deficit (CAD) and still allowed the RBI to accumulate foreign exchange reserves. That is why a CAD of around 2 per cent of GDP came to be seen as safe. Over the last couple of years, however, capital inflows have weakened steadily and, at current levels, they are no longer sufficient to finance even a modest CAD.

There is another reason why foreign capital matters. The government’s goal of making India a "Viksit Bharat" by 2047 will require the economy to grow at around 8 per cent a year, in real terms, for the next two decades. Achieving that will require much higher investment. Domestic savings alone are unlikely to be enough. Foreign capital will, therefore, have to fill part of the gap.

Consider the incremental capital output ratio (ICOR). It measures how many rupees of investment are needed to generate one additional rupee of GDP. India's ICOR has historically ranged between 4.5 and 5. At that rate, sustaining a real GDP growth rate of 8 per cent requires investment of 36-40 per cent of GDP every year.

Today, India's gross savings and investment are both around 30 per cent of GDP. Raising investment to the level needed for sustained high growth would, therefore, require an additional 6-10 per cent of GDP every year. At today's GDP of around $4 trillion, even the lower end of that range amounts to roughly $240 billion a year in investment. Unless domestic savings increase substantially, India will need foreign capital to bridge this gap.

The obvious question, then, is how India can attract more foreign capital. The RBI's June 5 package, especially the elimination of capital gains tax on foreign investors’ bond purchases, is a step in the right direction. But much more needs to be done. For example, nothing has been announced so far to encourage foreign direct investment (FDI). This matters because FDI is not only more stable than portfolio investment, but also brings technology and access to global production networks that India needs to build a competitive manufacturing sector.

To encourage FDI inflows, three policy actions are crucial. The first step is to liberalise India's trade regime. Import tariffs need to come down. The Customs duty structure should be simplified. Quantity control orders (QCOs) that make it harder for manufacturers to source imported inputs also need to be phased out.

Second, policymakers need to rebuild the bilateral investment treaties (BITs) network that was dismantled entirely between 2016 and 2024. Setting up a factory requires a large, long-term investment. Foreign investors are more likely to make such commitments when they are confident that any disputes will be resolved through a credible and predictable legal process.

Third, policy certainty matters. Investors making long-term commitments need confidence that the rules will not change after their investments are made. The retrospective tax dispute involving Vodafone damaged that confidence. Although the government has since ruled out such taxation, more recent policy reversals have kept those concerns alive. The RBI's decision in March requiring banks to unwind their offshore forward positions, at an estimated cost of hundreds of millions of dollars, is one example. Whether or not the policy was justified, unexpected changes of this kind increase the perceived risk of investing in India.

The RBI’s June measures have bought India some time. The challenge now is to use that time wisely. India needs a permanent strategy to attract foreign capital, especially foreign direct investment. That means making it easier to invest, protecting investors through predictable rules, and avoiding policy reversals after investments have been made. 

Indian policymakers cannot guarantee that foreign capital will come. But they can ensure that there are no avoidable reasons for it to stay away.

The Rupee's problems runs deeper

Business Standard June 15, 2026

On June 5, the Indian authorities took out a bazooka to rescue the rupee. The RBI announced a series of measures, providing subsidies to state-owned companies taking overseas loans, introducing a new version of the dollar-deposit scheme for NRIs, last seen in 2013, and removing restrictions on foreign investment in bonds and equities. At the same time, the government exempted foreign investments in government bonds from tax on interest and capital gains. The announcements are ambitious in scope. But will they be effective? There are reasons to be sceptical.

To begin with, it is important to recognise that the rupee’s weakness has not been caused solely by the war in West Asia. In fact, the rupee was the worst performing currency in Asia last year, depreciating by more than 6 percent against the dollar. This suggests that there is more to the story. The obvious question is: why have foreign investors been taking money out of an economy that, according to the latest official data, is growing at nearly 8 percent, faster than any major economy in the world?

The answer lies in two other shocks that India has been facing. These shocks have received relatively less attention but are likely to have a longer-lasting impact. What are these shocks and how should the economy adjust?

The first of these could be termed the China shock. Until recently, the dominant narrative among investors was that India would gain significantly from the shift of global manufacturing out of China. The logic seemed compelling: a vast pool of low-cost labour, the government’s incentive schemes for the manufacturing sector and a rapidly expanding domestic market. Since 2008, India’s GDP has risen fourfold, from about $1 trillion to $4 trillion, reinforcing the perception that the country offered both a production base and a sizeable consumer market.

However, things have not turned out as expected. For a start, the shift out of China has been smaller than anticipated. China continues to be the workshop of the world, even expanding into new sectors (such as automobiles) where it previously did not have any major international presence. Moreover, the manufacturing that has shifted out of China has generally not come to India. Gross FDI to India has in fact fallen as a percent of GDP, from 3.6 percent in 2008 to less than 1 percent in 2024. The major beneficiaries of the China+1 shift have been in East Asia, with Vietnam in particular seeing its FDI ratio surge to more than 5 percent.

While foreign firms have been reluctant to invest in India, Indian firms have been expanding their investments abroad. Outward FDI has doubled over the past two years from roughly USD 15 billion to more than USD 30 billion in 2025-26, even as domestic investment has remained sluggish. In other words, India has not been able to present itself as an attractive manufacturing location, either to foreign or to domestic firms.

In addition to this, the economy is facing a second major shock: AI, which is threatening the country’s flagship IT sector. Despite India’s software prowess, it is lagging well behind the US and China in developing AI platforms and shaping global AI development. The Nifty IT index has fallen roughly by 22 percent over the past year. This in turn has forced the IT firms to retrench. Hiring has fallen sharply, while anecdotal evidence suggests that the top IT firms have laid off around 40,000-50,000 employees since 2024.

Taken together, these two shocks have exposed the vulnerabilities in India’s growth narrative. If the twin drivers of manufacturing and IT services are under strain, where will sustained, high growth come from? New pillars can certainly emerge; they have in other Asian economies. China, South Korea, and Taiwan have proved their potential to move up the value chain and establish a global presence in frontier industries such as AI hardware and electric vehicles. The Indian manufacturing sector however, has yet to make a similar transition.

The takeaway is straightforward. As expectations of India’s growth prospects have moderated, both FDI and portfolio flows have weakened, to the point where they are no longer sufficient to finance even a modest current account deficit. This implies that short-term dollar inflows triggered by the recently announced measures are unlikely to solve the problem. Instead, the economy needs to adjust.

There are two ways this could play out. One way is for investors to mark down the prices they are willing to pay for Indian assets, to reflect the economy’s weaker growth prospects. Under this scenario, share prices would correct, pulling market valuation down from its lofty 20-23 price to earnings ratio to the 12-17 range more typical of emerging economies. Alongside this, the Indian rupee would depreciate further. As Indian assets become less expensive, foreign capital will eventually be enticed to return, in sufficient quantity to finance the current account deficit, now running around $100 billion a year.

Such a scenario would not be particularly appealing because those who have invested in Indian assets would lose considerable amounts of money.

The alternative is to restore confidence in the economy’s growth prospects. This is a better option but it is also harder to achieve. It would require decisive measures to address the factors holding back investment-both domestic and foreign. It would also require something that has so far been in short supply: a willingness to recognise that the concerns being expressed by investors may not be entirely misplaced.

Why RBI’s regulatory intervention is the wrong way to defend the rupee

Why RBI’s regulatory intervention is the wrong way to defend the rupee, The Print, June 1, 2026.