Dollar and the diaspora: Old courtship, new script in forex strategy

NRI money can steady a wobble but it's not a substitute for durable capital inflows. We need structural changes in the bond and equity markets

Every few years, when the rupee starts to wobble and foreign exchange reserves begin to thin, India remembers an old friend: The non-resident Indian (NRI). The red carpet, rolled up and stored since the last crisis, is dusted off, and the courtship begins.

 

The central bank reaches for the NRI’s wallet when easier options run out. Early this month, the Reserve Bank of India (RBI) and the government unveiled a clutch of measures to pull foreign currency back into the country. Around that time, the rupee was hovering at 95 to the dollar, down about 6 per cent for the year. Foreign reserves had slipped from a February-peak of roughly $728 billion to around $682 billion. The Hormuz crisis had pushed the price of Brent crude above $100 a barrel, foreign portfolio money was leaving equities, and the trickle of NRI dollar deposits that had been worth some $7 billion in 2024-25 had all but dried up.

 

Stripped of the jargon, the package has six parts:

 

First, the government scrapped the tax on foreign institutional investors’ earnings from government bonds — both interest and the capital gains — through an ordinance.

 

Second, the RBI widened the menu of government securities foreigners can buy freely under the so-called Fully Accessible Route, adding long bonds and loosening the limit on how much and how short-term foreign portfolio investors could go.

 

Third, it made it easier for NRIs, Overseas Citizens of India and a broader set of non-resident individuals to buy listed Indian shares without having to register with the market regulator.

 

Fourth, it offered public-sector firms a cheap hedging facility on their overseas borrowings.

 

Fifth, it threw open a special window for Foreign Currency Non Resident (Bank) FCNR(B) deposits.

 

Sixth, it also allowed banks to borrow under the Overseas Foreign Currency Borrowing (OFSB) route. For the money raised through external commercial borrowing (ECB) and OFSB route, the RBI is only charging 1.5 per cent from public sector units (PSUs) and banks to swap the dollar for rupee for the maximum period of five years. 

 

The first three measures are structural – to make India a permanent home for global capital. 

 

The FCNR(B) window is tactical and time-bound. When an NRI places dollars in an FCNR(B) account, the bank doesn’t keep them under a mattress – it converts them to rupees and lends them out.  Three or five years later, it hands the dollars back. So, the bank has to insure itself against the rupee weakening in the meantime. That insurance, or cost of hedging, is roughly 3 per cent a year. This eats into the interest the bank can offer the depositor.

 

Under the new swap window, a bank takes the NRI’s dollars, sells them to the RBI for rupees at a fixed reference rate, and agrees to buy the same dollars back at the same rate when the deposit matures. As the exchange rate is locked at both ends, the bank carries no currency risk on principal — the RBI does. Banks are, however, open to exchange rate risks for the interest rate component. If they wish to hedge that, it can add 0.5 per cent to 0.75 per cent to their cost. Additionally, there is a waiver on the cash reserve ratio (CRR) or the money that commercial banks keep with the central bank on which they don't earn any interest and statutory liquidity ratio (SLR) -- mandatory investment in government bonds that banks normally set aside from deposits.

 

It’s a win-win for both the banks and the depositors. The window covers fresh three-to-five-year deposits opened until September 30, and the swaps can be executed until mid-October.

 

Rates that sat at around 3.5-5 per cent before June have zoomed as the RBI has given banks the freedom to set the rates on such deposits as well as rupee-denominated NRE deposits.

 

India has dialled the diaspora in every external squeeze during the last three decades.

 

The State Bank of India raised $1.6 billion through India Development Bonds in 1991, when a balance of payments crisis struck the nation.

 

After the Pokhran nuclear tests and the western sanctions that followed, the Resurgent India Bonds in 1998 raised about $4.2 billion at 7.75 per cent on the dollar tranche.

 

The India Millennium Deposits of 2000 brought in $5.5 billion at 8.5 per cent.

 

Finally, during the 2013 taper tantrum, when the rupee was in free fall, roughly $26 billion was raised through FCNR(B) deposits and overall about $34 billion through related swap windows in three months.

 

The first three bonds were quasi-sovereign bullet issues, raised by SBI on the government’s behalf. The 2013 scheme and the current one work through the banking system, with the RBI carrying the currency risk on its own books.

 

How much money can be raised this time? It's the same sport being played but the turf is different. In 2013, the US Federal Reserve’s policy rate was 0-0.25 per cent, its historic floor. A dollar earned almost nothing abroad. So, a 4-5 per cent dollar deposit in India looked irresistible.

 

That gap has narrowed dramatically. The Fed funds rate now sits at 3.50-3.75 per cent and US Treasuries yield around 4.5 per cent. A risk-free dollar already earns a respectable return at home. An Indian bank offering 6-7 per cent is beating the US alternative by 1.5-2.5 percentage points, not by the margin of 2013. And, for a US-resident NRI, the interest is taxable in America, which thins the advantage further.

 

The heavy lifting this time is being done not by the rate gap but by the RBI itself — by absorbing the roughly 3 per cent hedging cost. In 2013, the central bank only partially subsidised that cost; as the hedging cost was higher due to the high interest rate differential between the US and India. This time it is bearing it in full, and offering banks the swap at a cheaper fixed rate.

 

There is, however, a turbocharger — the same one that made 2013 fly: Leverage. NRIs can borrow against their FCNR(B) deposits, often through an overseas branch of the same Indian bank, with the deposit pledged as collateral and backed by a standby letter of credit. Keep a dollar deposit, borrow against it, redeposit, and repeat.

 

The RBI is not telling banks by how many times a depositor can leverage. Many banks, I hear, are allowing nine times. 

 

Going by the estimates of different analysts, at five times leverage, the annualised return can reach about 12 per cent; at seven-to-ten times, estimates stretch to 17-27 per cent in dollar terms. These are gross returns, pre-tax. Also, I presume, every depositor will not be allowed to leverage as it cuts both ways: A borrowed bet is only as safe as the lender’s willingness to keep rolling it.

 

By a conservative estimate, here is a repatriable, currency-risk-free dollar asset yielding 6-7 per cent. This will definitely appeal to NRIs who want dollars working without rupee exposure.

 

Brokerage estimates peg the inflow between $30 billion and $60 billion. My own reading leans to the lower-to-middle of that band — $30-45 billion of inflow. The higher figures will be achieved only if the leverage trade catches fire, as it did in 2013.

 

Even at the top end, the haul would be only around 2 per cent of the banking system’s deposit base — useful ballast for the balance of payments and the rupee, not a structural fix.

 

And, there is a cost. The RBI is taking the currency risk onto its own books. If the rupee depreciates meaningfully over the next three to five years, it will bear the loss when the swaps reverse, just as it did after 2013.

 

This is borrowed time bought with a contingent liability. It can steady a wobble but won’t be a substitute for durable capital inflows.  For that, we need structural changes in the bond and equity markets.