Monetary policy: Reserve Bank of India opens window for dollar inflow

RBI has unveiled a five-pronged plan to attract foreign capital, boost dollar inflows, ease banking liquidity pressures and support the rupee

First things first. The Reserve Bank of India (RBI) bites the bullet and opens up the window for dollars to flow in. 

The June monetary policy has announced a five-pronged strategy to attract foreign capital. 

First, it will offer concessional forex swaps till September 30 to encourage public sector undertakings to raise external commercial borrowings. 

Second, it will bear the full hedging cost of banks for raising three-to-five-year non-resident Indian deposits. This window too will remain open till September 30. In his post-policy media interaction, RBI Governor Sanjay Malhotra said these deposits will not attract reserve requirements such as cash reserve ratio and statutory liquidity ratio.   

Third, the RBI has expanded the bouquet of government securities under the so-called Fully Accessible Route to attract foreign investors. All new long-term bonds with tenures of 15, 30 and 40 years are being added. In addition, the cap on short-term investments in the bond market by foreign investors too is being removed. 

Fourth, the cap on investment by non-resident Indians and overseas citizens of India in equities traded on the stock market without Securities and Exchange Board of India registration is being lifted and the same facility is being extended to all individual persons resident outside India or PROIs. 

Finally, it is reverting to the old timeline of bringing back export proceeds to India – nine months. In November last year, the RBI had extended it to 15 months. 

The cumulative effect of all five measures will be dollar inflow. The last time, in 2013, when the taper tantrum hit the world, the RBI asked banks to raise dollars through the Foreign Currency Non-Resident Bank [FCNR(B)] route, subsidising the swap cost. The banks had raised $26 billion against a target of $10 billion. Overall, India raised $34 billion foreign currency funds that year.

This time, there is no target fixed by the RBI. Malhotra expects “reasonable” and “healthy” flows. The market expects anywhere between $40 and $50 billion inflow. 

As on May 12, foreign institutional investors’ holding is little over ₹3.75 trillion out of the total outstanding government bond portfolio of ₹112.42 trillion. The new norms and the removal of the 20 per cent withholding tax on interest earned from government securities for eligible foreign investors and 12.5 per cent long-term capital gains tax will encourage foreign investors to buy Indian bonds. 

In some sense, it is the internationalisation of the Indian bond market. Globally not too many countries impose such taxes. It will also be an incentive for global bond indices to include Indian bonds. They have been included in the JP Morgan Emerging Markets Bond Index and other emerging market benchmarks but the flagship Bloomberg Global Aggregate Index has kept the entry on hold, pending operational and market infrastructure assessments. 

All these measures will serve two objectives: The dollar inflow will address the fund crunch the banks are facing and stem the currency deprecation. As the banks are expected to pass on the hedging cost benefit to their customers, the cost of money will also come down. This will help banks improve their net interest margin. As per the latest available data, year-on-year credit growth is 15.4 per cent in FY2026, compared with 12.1 per cent a year ago. 

The rupee closed at 94.9450 a dollar on Friday, against 95.78 on Thursday. The 10-year bond yield closed just one basis point lower at 6.98 per cent against the previous close of 6.99 per cent but the five-year bond yield was sharply down, from 6.8 per cent to 6.65 per cent. 

Along expected lines, the six-member Monetary Policy Committee (MPC), the RBI’s rate-setting body, has unanimously decided to keep the policy repo rate unchanged at 5.25 per cent. The stance also remains neutral. 

There is also no surprise in the growth and inflation estimate of the RBI. 

The RBI has cut down the real GDP growth estimate for FY2027 from 6.9 per cent to 6.6 per cent with “downside” risks. Quarter-wise, the growth projections are 6.6 per cent for the first quarter, 6.3 per cent for the second, 6.5 per cent for the third, and 6.8 per cent for the fourth quarter. If global supply chain disruptions continue, financial markets remain volatile for long, and there is an El Niño shock, growth may come down further. 

When it comes to consumer price index (CPI) inflation, the projection has risen to 5.1 per cent for FY2026 from 4.6 per cent earlier with upside risks. Here, the quarter-wise projections are 4.2 per cent in the first quarter, 5.1 per cent in the second, 5.9 per cent in the third, and 5.4 per cent in the fourth quarter. Core inflation is projected at 4.7 per cent. Global supply chain disruptions, commodity price shocks and insufficient rainfall during the monsoon are the risks. The 5.1 per cent inflation projection is also based on an assumption of crude price at $95 a barrel. 

 The governor’s statement says, “We shall put in place policies to meet the challenges while taking measures to further strengthen the macroeconomic fundamentals of the country.” 

The key question is: When will the RBI raise the repo rate? Since the CPI inflation is projected at 5.1 per cent, the repo rate cannot remain at 5.25 per cent. Without getting into the debate of what should be the real rates -- interest rates adjusted for inflation – it’s safe to assume that the repo rate needs to go up to at least 6 per cent if indeed inflation is contained at 5.1 per cent. 

Will the RBI wait till the October policy, by when it will know how much foreign funds have flown into India? The windows for foreign fund flows close in September. It may. But, if geopolitical uncertainties and an indifferent monsoon queer the pitch for inflation further by next month, forcing the RBI to raise the inflation estimate further, I will not be surprised if the rate hike, a first in the series, happens in August.  

For now, let’s keep our fingers crossed.

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The writer, a consulting editor at Business Standard, is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book is Roller Coaster: An Affair with Banking. To read his previous columns, log on to www.bankerstrust.in 

X: @TamalBandyo