The search for durable capital

The dollar-rupee forex swap was necessary and successful. Now, it is time to weigh the pros and cons of making capital inflows more attractive

The Reserve Bank of India has reported that it has provisionally mobilised $136.37 billion under its special dollar-rupee forex swap facility, with foreign currency non-resident or FCNR(B) deposits contributing $127.23 billion, constituting 93 per cent of the total. The inflows have been much larger than expected, and the RBI had to close the FCNR(B) swap facility one month early. Such large forex flows provide much-needed support to the balance of payments (BoP) and to the rupee.

 

This is not the first time such a scheme has been launched. A similar scheme was introduced in 2013 in the aftermath of the taper tantrum episode. However, unlike in 2013, when the current account deficit (CAD) was elevated, at close to 5 per cent of gross domestic product or GDP, this time the scheme has been introduced amid market expectations of a BoP financing need this year. Unlike 2013, CAD has remained at modest levels, at 0.7 per cent of GDP in 2023-24 ($26 billion) and 0.6 per cent in 2024-25 ($23.3 billion).

 

Foreign portfolio investment (FPI) equity outflows were about $19 billion in calendar 2025 and have been about $25 billion so far in 2026, including $13 billion in March 2026 alone. Net foreign direct investment (FDI) was meagre at around $0.4 billion in 2024-25 due to large repatriations and outward FDI. The rupee depreciated to a new all-time low of near ₹97 per dollar in May 2026 and remained under pressure thereafter.

 

Therefore, while forex reserves mobilised under the FCNR(B) window have provided a huge comfort, there is a need to address long-term concerns without further loss of time. India has run an average current account deficit of 1.9 per cent of GDP in the last 20 years and in a business-as-usual scenario, the CAD is expected to be around 2 per cent of GDP in the next few years. Financing a CAD of 2 per cent year after year needs durable sources, preferably non-debt creating, unlike the FCNR(B) deposit special facility, which is lumpy and very expensive.

 

The cost of hedging — the difference between market forward premium and concessional swap rate — will be borne by the RBI.  In 2013, analysts assessed the implied cost of the concessional swap window of $26 billion at ₹15,000-20,000 crore over the life of the swap. With overall forex inflows under the current facility already at $136 billion — nearly five times larger — the resulting cost will be sharply higher, which will dent the RBI’s profits and subsequent surplus transfer to the government over the life of the swaps.

 

It is true that FPIs are here to make money. However, it is also true that we need them to finance CAD. While FPI flows are inherently volatile and driven by global risk-on/risk-off, they had, on balance, provided solid support to BoP until the recent bout of outflows. It is, therefore, time to examine whether there are some irritants that have driven FPIs away.

 

FPIs in India face relatively high costs. After the July 2024 Budget, long-term capital gains tax on listed equities is 12.5 per cent and short-term is 20 per cent plus applicable surcharge and cess. India is among the few large markets that levy both securities transaction tax (STT) and capital gains tax. The key friction flagged by FPIs is double taxation, as taxes paid in India are often difficult to claim as foreign tax credit at home. While taxation is not the primary driver of recent outflows, the combination of STT plus capital gains tax and persistent rupee depreciation reduces post-tax dollar returns and makes India less competitive compared to its peers.

 

After the 1991 BoP crisis, our policy has been to encourage non-debt creating flows. Compared with high-cost  rupee- dollar forex swap funds, it is better to make our markets more attractive to non-debt creating capital flows by examining how far their genuine concerns can be addressed.

 

India is one of the fastest-growing economies, yet private corporate investment remains stubbornly weak, hovering around 11 per cent of GDP, a far cry from the peak of nearly 17 per cent during the 2003-08 capex cycle. At the same time, domestic firms are investing heavily abroad. To bridge this paradox and secure durable, non-debt capital, India must attract greater FDI by offering more regulatory certainty, time-bound dispute resolution and lower compliance costs. Addressing these domestic anxieties is vital to attract global investors and retain domestic capital.

 

The massive foreign exchange inflows have flooded the banking system with durable surplus liquidity, pushing the weighted average call rate well below the RBI repo rate. This undermines the very first leg of monetary policy transmission, especially when inflation has started firming up. It is time to consider durable absorption tools such as the cash reserve ratio to mop up the current durable liquidity surplus of over ₹8 trillion and ensure overnight market rates align tightly with the policy repo rate.

 

The dollar-rupee forex swap window was necessary and successful. However, it is now time to weigh the pros and cons of making capital inflows more attractive vis-a-vis resorting to such expensive extraordinary measures. We must attract durable non-debt creating capital inflows to avoid such extraordinary measures in the future.

 

The writer is senior fellow, Centre for Social and Economic Progress, New Delhi.

 

The views are personal