RBI follows the herd

The Monetary Policy Committee of the Reserve Bank of India, in their meeting held during 5-7 October, 2026, unanimously decided to hike the policy rates by 25bps, in line with the market consensus. Accordingly, the policy repo rate is hiked from 5.25% to 5.50%; the standing deposit facility (SDF) rate stands adjusted at 5.25% and the marginal standing facility (MSF) rate and the Bank Rate at 5.75%. The MPC also decided to change the stance to “calibrated tightening” from “neutral”, by a 4-2 majority vote. This is the first rate hike by RBI since February 2023.

Explaining the policy decision backdrop, the Monetary Policy Report (October 2026), emphasized-

“Going forward, India’s macroeconomic outlook remains resilient supported by domestic demand and strengthening investment, despite persistent global uncertainties. The outlook remains vulnerable to geopolitical developments, volatility in global energy markets and weather-related uncertainties. Weak monsoons coupled with strong El Niño, protracted geopolitical tensions, rising international commodity prices, additional frictions in global trade and tightening of global financial conditions could adversely impact the growth outlook. Persistent supply-side pressures in food and volatile global energy prices pose risks to the domestic inflation outlook, particularly through second-round effects amid strong growth impulses. The interplay of these factors will shape the evolving growth–inflation dynamics, with the balance of risks depending on developments in global growth, crude oil prices, exchange-rate movements, and domestic food supplies.”

As I mentioned in my yesterday’s post (see here), the decision to hike and change of stance to calibrated tightening was well anticipated and analyzed by the market participants. There is not much to comment on that. Nonetheless, I find the following two points worth highlighting:

1.    The RBI has hiked its real GDP growth estimates for FY27 from 6.7% to 7.1% to underscores the strength of economic activity despite significant headwinds. This can also be interpreted to mean that the RBI does not see the latest rate hikes as restrictive.

2.    The RBI increased its inflation estimates for FY27 core inflation by 10bps to 4.4% (previously 4.3%). It also estimates that the headline CPI inflation may average 5.8% in the next three quarters (3QFY27 to 1QFY28). The RBI governor, in his statement, admitted that “there is limited evidence of demand side pressures”. He also highlighted that “As regards supply side inflation, the MPC noted that monetary policy primarily acts by curtailing second round effects (inflation expectations and firm level pricing behavior, etc.), which take time to manifest and are difficult to extract from available data….While there is some evidence of elevated inflation expectations and generalisation of inflation, there are limited signs of supply side pressures getting embedded in pricing behaviour.” In plain English, it implies that the RBI is not sure whether the latest rate hike could help in controlling inflation.

Overall, the decision to hike appears more of a preemptive move to check INR depreciation and attract flows in treasury bonds, as the central government and states get ready to make large issuance in 2HFY27. The assumption seems to be that in view of the abundant liquidity in the banking system, the transmission of this hike to borrowers may happen with considerable lag.

I would be carefully watching the transmission channels to assess the implications for my investment strategy.

 

To hike or not to hike

In a few hours from now, the Reserve Bank of India will announce the outcome of the Monetary Policy Committee (MPC) meeting held from 5 to 7 October 2026. The market consensus is a 25bps hike in the policy repo rate, from 5.25% to 5.50%. It would be the first increase since February 2023. A few analysts also expect a hike in the Cash Reserve Ratio (CRR) from the current 3%. The RBI’s stance has been “neutral” since June 2025, and it was retained in August. The talk now is that the RBI may move to “calibrated tightening”, though economists are far from united on this.

Two reasons are being given for a hike. The first is sticky inflation. CPI inflation rose to 4.82% in August, above the 4% target for the third month in a row, and wholesale inflation is close to 10%. The second is the shrinking gap between Indian and developed-market bond yields. The US Fed has started raising rates again, the rupee is close to 96 to the dollar and about 6% weaker this year, and foreign investors have been taking money out of Indian bonds.

Let me be clear about where I stand. In my 24 September post I had said that a 25-50bps move in October was now the base case, and I still expect the MPC to hike today. But what the RBI will do and what it needs to do are two different questions. On the second, I am not convinced. In my view, the reasons being given are not strong enough for the RBI to change the course of its policy.

Inflation is a supply story

Energy is dearer because of the war in West Asia and disrupted shipping. Food is dearer because the southwest monsoon is closing with a deficit of around 15%, and El Nino is strengthening. Metals and chemicals are dearer because of freight costs and production disruptions in several countries. A higher repo rate will not bring one extra barrel of crude through Hormuz, or one extra drop of rain. Core inflation, which leaves out food and fuel, was still 3.9% in July. That is not how demand-led overheating looks.

History is not encouraging either. The RBI raised rates twice in 2018 as oil climbed and the rupee slid, and the rupee kept weakening until crude prices turned in October.

The fair counter-argument is second-round effects, when supply shocks seep into wages and inflation expectations. I take that risk seriously, and it is the one reason I would not rule out more hikes later. But the core inflation numbers do not show it yet.

Borrowing costs will bite where it hurts

Indian businesses are already carrying more working capital, because inventories are higher and payment cycles are longer. A costlier loan at this stage will also find its way into prices, besides adding to financial stress.

Bond yields have also done part of the RBI’s job already. In the past one month the 2yr G-Sec yield is up 51bps, the 10yr by 25bps, the 15yr by 30bps and the 30yr by 10bps. A 25bps hike will not move these yields in the same proportion, but it will reach households. A large part of floating-rate home, auto and MSME loans is now linked to the repo rate, so EMIs will go up within a few months. Demand in these rate-sensitive segments is already softening. Housing sales in the top nine cities fell 6% in the September quarter from a year ago, though another tracker covering seven cities shows a 3% rise, so the picture is mixed. In autos, September numbers missed expectations a month after record sales in August. Bajaj Auto’s domestic sales were down 9% and M&M’s tractor sales 21%, even as M&M’s overall sales and Hyundai’s held up. With the RBI itself projecting growth of 6.7% I am not worried about a collapse. My concern is narrower. These are the segments where costlier EMIs bite first, and the festive season is a poor time to test them. Why add to their burden when the inflation we are fighting does not come from these sectors?

The yield gap is the better argument, but still not enough

Of the two reasons for a hike, this is the stronger one, because it is about the rupee and capital flows. But look at the size of the moves involved. The Fed has gone from 3.50-3.75% to 3.75-4%, and the US 10-year yield has crossed 5%. A 25bps hike by the RBI does very little to a gap that is being pulled open by moves of that size elsewhere. Foreign flows into our bonds are following global yields, not 25bps of repo rate. Besides, the RBI has already pulled in large inflows through the FCNR(B) window, eased the norms for external commercial borrowings and stepped into the currency market. These tools are aimed straight at the rupee, and I would rather see the RBI lean on them.

I accept that there is a cost on the other side too. The market is expecting a hike, and a surprise hold would unsettle the rupee and bond yields for a few days. To me that is a smaller price than raising the policy rate for reasons it cannot address.

What the RBI can do instead

The real anomaly right now is the excess liquidity due to FCNR(B) mobilization. Short-term money market rates are still trading below the repo rate. The RBI has been absorbing this through bond sales and swaps, and more of the same would bring overnight rates up towards 5.25%. Let us not pretend that this is not tightening, because it is. But it is a more precise kind of tightening, it does not announce a new rate cycle, and it can be reversed easily. Among the tools, I would prefer open market sales and swaps over a CRR hike. CRR is a blunt instrument, and a hike would take back relief that banks got only last year.

The sharp rise in personal loans is the part of credit that needs cooling. Bank credit is growing at about 19% against deposit growth of about 15%. Targeted steps, such as higher risk weights on unsecured loans as the RBI did in late 2023, will do this better than a rate hike that every borrower in the country has to pay for.

Investor takeaway

·         Look beyond the repo rate today. A 25bps hike is largely priced in. The stance, the guidance for December and any liquidity measures will tell you more.

·         Watch the RBI’s liquidity operations as closely as the headline rate. Overnight rates moving up towards 5.50% is tightening, whatever the repo rate does.

·         Expect rate-sensitive segments – real estate, autos, NBFCs and companies with heavy external borrowings – to feel the higher funding costs first.

·         Do not assume that one hike ends the story, and do not build a base case around rate cuts. A higher cost of capital for longer remains my working assumption.

·         If the RBI holds, expect the rupee and bond yields to react first. Treat that as a short-term reaction, not a change in the larger direction.

A closing thought

The Bhagavad Gita (6.17) says that yoga removes sorrow for the one who is measured in eating, in recreation, in action, and in sleep and waking:

युक्ताहारविहारस्य युक्तचेष्टस्य कर्मसु । युक्तस्वप्नावबोधस्य योगो भवति दुःखहा ॥

The word to notice is yukta – measured, fitting. Central banking asks for the same quality: choose the dose that fits the ailment, neither more nor less. A hike may well come today. My only point is that the ailment here is mostly one that a rate hike cannot treat, and the RBI has finer instruments for the rest.

Higher for Longer – investment strategy guardrails

I closed my last post promising to come back with what the “higher for longer” regime means for portfolios (see here). Before I get there, it is worth pausing on where the RBI itself stands in this story, because India’s hand is not quite the same as the one the Fed, the BoJ or the ECB are holding.

The repo rate has sat at 5.25% through four straight policy reviews. Going into the October 5-7 meeting, the conversation among economists has shifted from “will the RBI hold” to “how much will it raise.” A hawkish pause is no longer the base case doing the rounds; a 25-50bps move in October, with more to follow in December, is. By the time this cycle is done, my own sense is the repo rate ends up a good 50-75bps above where it sits today.

Curiously, short-term money market rates are still trading below that 5.25% mark, not above it. That is the FCNR(B) window talking – the RBI’s special swap facility pulled in close to $133bn of NRI deposits by the time it shut at the end of August, and together with external commercial borrowings and overseas foreign currency borrowings, total inflows under the facility had crossed $143bn by mid-September. That is a lot of rupee liquidity sloshing around the banking system, and the RBI has been mopping it up through fairly aggressive open market bond sales rather than touching the policy rate itself. Even so, the benchmark 10-year G-sec yield has stayed above 7% for weeks now, and the curve remains steep at the long end – the market’s way of saying it does not fully believe the short-end calm will last.

On the inflation side, August CPI came in at 4.82%, up from 4.45% in July, and food prices are doing most of the damage. The southwest monsoon is closing out with a deficit of around 15%, and forecasters now see the El Nino in the Pacific strengthening further as we head into winter, which puts a question mark over the rabi season and, by extension, over food inflation through the next two quarters. A rupee that keeps flirting with the 96-to-the-dollar mark is not helping either – whatever pass-through shows up in energy and other imported inputs adds to that same pressure. Food and energy together, then, not a demand story, look set to be the swing factor for inflation over the next six months.

Growth, meanwhile, refuses to cooperate with the doom-mongers. The RBI’s own FY27 estimate has been revised up twice this year to 6.7%, and a clutch of private forecasters now sit closer to 7%. With growth this resilient, there is little reason for the MPC to look past the inflation print in its trade-off, and every reason to expect it will keep leaning towards price stability rather than growth support.

So, what should the investment strategy stance be under these circumstances? In my view, investors should –

•      Not build a base case around imminent rate cuts, in India or anywhere else; price discovery for equities and bonds should assume the current cost of capital persists into 2027.

•      Treat AI-linked disinflation as a slow-moving, narrow effect, not a macro offset to energy-driven inflation.

•      Watch the RBI’s non-rate toolkit as closely as the repo rate itself; between the $143bn of FCNR(B)/ECB/OFCB inflows, OMO sales and swap operations, it is currently doing more of the work than the headline number suggests.

•      Size allocations to alternatives such as gold and crypto around the structural, diversification-driven demand from central banks, rather than around the cyclical, rate-driven leg, which has already started to fade.

•      Favor balance sheets and business models that can absorb a higher cost of capital for longer, rather than ones underwritten on the assumption that cheap money and a fresh round of quantitative easing would be back before too long.

The broader lesson is one the Gita states more elegantly than any market commentary can – yogasthah kuru karmani, act with steadiness, without being swayed by outcomes that keep shifting day by day. The rate cycle will turn again eventually. Portfolios built on patience will be in better shape to meet that turn than those built on guessing when it arrives.

 

Thought for the day

“Bigamy is having one wife too many. Monogamy is the same.”

—Oscar Wilde (Irish Poet, 1854-1900)

Word for the day

Enormity (n)

Outrageous or heinous character; atrociousness

India’s External Debt: The Post-Covid Slippage Investors Can’t Ignore

 The Reserve Bank of India put out its quarterly external debt release on 29th June 2026, and as usual, the headline number got a polite nod and nothing more: India’s external debt stood at US$ 762.8 billion at the end of March 2026, up US$ 26.3 billion over the year, taking the debt-to-GDP ratio to 20.8% from 19.8%. On the surface, unremarkable. But when we look at the internals, the story that emerges is less reassuring than the headline suggests. The external sector isn’t in danger, but it has quietly become more fragile since the post-Covid recovery years, and that fragility matters for how we think about the rupee and India’s external financing risk over the next few years.

A manageable ratio, a weakening structure

The debt-to-GDP ratio at 20.8% remains comfortably in what economists would call manageable territory, and it isn’t wildly different from the 21.1% recorded in 2021, the last full year still shadowed by the pandemic.

However, the foreign exchange reserve cover for total external debt has fallen from 100.6% in 2021 to 90.6% in 2026. The share of short-term debt (original maturity) in total external debt has risen from 17.6% to 19.6%, and short-term debt as a proportion of forex reserves has climbed from 17.5% to 21.6%. Each of these is a small move in isolation. Together, they describe a debt profile that is shorter in tenor and less well cushioned by reserves than it was three years ago.

The debt service ratio is the one metric that needs a more careful read, because a straight 2021-to-2026 comparison is flattering — it fell from 8.2% to 5.8%. But 2021 was still a Covid-distorted year with depressed current receipts inflating the ratio. Using the post-pandemic trough of 5.2% in 2022 as the fairer base, the ratio actually climbed for three straight years, peaking at 6.7% in 2024, before easing back to 5.8% in 2026. That is not a story of steady deterioration, but it is not a story of steady improvement either — it is a debt service burden that has been more volatile and, on trend since the 2022 low, higher than the immediate post-pandemic years.​

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None of this is a crisis signal. But it is a genuine, multi-year softening in India’s external debt buffers since the immediate post-Covid years — exactly the kind of quiet deterioration that headline ratios are designed to hide.

Who is doing the borrowing — and what it says about domestic savings

The more interesting story sits in the borrowers’ profile. Government external debt has risen from US$ 133.3 billion at end-March 2023 to US$ 167.5 billion at end-March 2026 — an increase of roughly 25% in three years. That is a meaningful acceleration in sovereign external borrowing, even though it remains a modest 4.6% of GDP.

Deposit-taking corporations — India’s banks, effectively the country’s lenders — have grown their external debt from US$ 163.4 billion to US$ 202.1 billion over the same period, a rise of roughly 23.7%. I read this as a signal worth sitting with: when banks lean more heavily on external borrowing, it is often because domestic deposit and savings mobilization isn’t keeping pace with credit demand. FCNR(B) inflows and forex swap windows, which I’ve written about in recent months, are part of the same story — the banking system reaching outward because the domestic liability side isn’t growing fast enough on its own.

Non-financial corporations, by contrast, have grown their external debt far more modestly — from US$ 242.5 billion to US$ 277.9 billion, an increase of about 14.6%. Corporate India has been comparatively restrained in tapping external debt markets even as government and bank borrowing has run well ahead of it.​

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The composition matters as much as the aggregate. A rising share of government and bank borrowing, growing faster than corporate borrowing, is consistent with a fiscal and financial system leaning more on external capital to plug gaps that domestic savings once filled comfortably. That ties directly into the fiscal-deficit-and-currency thesis I laid out in my recent post on rupee depreciation: subsidy and transfer liabilities pushing the government toward more external financing, even as it stays a small share of GDP.

The one-year wall: US$ 327 billion coming due

This is the number that should get more attention than it does. On a residual maturity basis — that is, counting all debt obligations falling due over the next twelve months, regardless of original tenor — India has US$ 326.9 billion of external debt maturing within one year. That works out to 42.9% of total external debt, and 47.3% of foreign exchange reserves.​

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Read that last figure again: nearly half of India’s forex reserves would be required to cover just the debt coming due in the next twelve months.

This is where the debt story connects directly to the currency story. A large share of this near-term debt will need to be rolled over rather than repaid outright — that’s normal in any economy with an active external debt market. But rollover risk is precisely the channel through which global risk-off episodes, a sudden Fed repricing, or a fresh leg of the West Asia crisis I’ve been tracking, could translate into real pressure on the rupee. When $327 billion needs refinancing within a year and reserve cover has thinned from 100.6% of total debt to 90.6% since 2021, the margin for error on the currency has narrowed, even if nobody is calling it a crisis today.

Investor takeaways

·         India’s external debt-to-GDP ratio remains manageable at 20.8%, but this headline number masks a genuine post-Covid weakening in reserve cover and debt tenor — don’t let the stable ratio lull you into complacency.

·         The debt service ratio’s apparent improvement since 2021 is partly a base effect; on trend since the 2022 low, the near-term repayment burden has actually risen before easing slightly in 2026.

·         Government and bank external borrowing are growing markedly faster (c.25% and c.24%) than corporate external borrowing (c.15%) since 2023 — a pattern consistent with slower domestic savings and deposit growth funding the gap through external channels.

·         US$ 327 billion of external debt — 43% of the total, 47% of forex reserves — falls due within a year. This is the single most important number in the release for anyone positioning for currency and rate risk over the coming twelve months.

·         None of this points to a solvency crisis. It does argue for staying selective on rupee-sensitive and import-dependent sectors, and for treating any near-term INR stability as a rollover-financing outcome rather than a structural improvement.

 

Stress-tested India!

The Reserve Bank of India (RBI) recently released the half-yearly Financial Stability Report (FSR) for June 2026. The report has come in the middle of a live geopolitical shock, therefore requires closer scrutiny. The broad message from the RBI is reassuring - the Indian financial system remains sound, even as the world around it gets noisier.

The RBI has framed the report against two forces reshaping the global economy and financial system — growing geopolitical fragmentation, and the technological disruption unleashed by artificial intelligence. The global economy, RBI notes, has stayed resilient so far, helped in part by optimism around AI-driven productivity gains. But the near-term outlook remains clouded given how quickly the environment keeps shifting.

The RBI captures the balancing act well: despite repeated shocks, the global financial system has shown notable resilience, with markets settling down after an initial bout of volatility triggered by the West Asia conflict. But global financial stability risks, the report cautions, remain elevated — lingering supply-chain uncertainty could still tighten financial conditions and reignite inflation, while high public debt, bond market fragilities, stretched asset valuations and the growing footprint of leveraged non-bank financial intermediaries (NBFIs) could all amplify the next shock.

On India, the tone is more reassuring. Domestic financial stability risks remain contained despite the global turbulence, the RBI says, underpinned by a strong banking system, healthy capital and liquidity buffers, and steady credit growth. India’s macroeconomic fundamentals, it adds, are stronger than those of many peers — and stronger than in previous crisis episodes — which gives the economy real buffers to absorb external shocks.

Some of the key highlights of the June 2026 FSR are listed below:

Global scenario

·         Markets held up, but the risk list hasn’t shrunk. The global financial system has demonstrated resilience through successive shocks, with markets turning more sanguine after the initial jolt from the West Asia conflict — helped by a smaller-than-feared rise in oil futures, strong corporate earnings and the AI-driven investment boom. Even so, elevated public debt, bond-market fragilities, stretched valuations and the expanding role of NBFIs remain live vulnerabilities.

·         Asset valuations look stretched, and AI stocks are a concentration risk. A sharp correction in global equities — particularly if triggered by a reassessment of AI-related earnings and valuations — could spill over into domestic markets. Debt financing by AI-linked companies has also been rising, a theme the FSR flags for the first time this cycle.

·         NBFIs keep growing in size and interconnectedness. The report flags the systemic importance of non-bank financial intermediaries and their deepening linkages with the banking sector as an area warranting close monitoring.

·         Cyber risk has a new face — AI. In a dedicated survey of 33 scheduled commercial banks and 10 upper-layer NBFCs, AI-enabled cyberattacks emerged as the single most significant risk expected over the next twelve months — ahead of ransomware, phishing and third-party or supply-chain risk. Even institutions confident about their overall cyber preparedness flagged the speed, scale and sophistication that AI brings to the threat.

Domestic economy

·         Growth headwinds from the conflict are receding, but not gone. With the signing of an interim peace deal, some pressure has eased, though the Indian economy and financial system remain exposed to geopolitical tensions and associated shocks. The Monetary Policy Committee (MPC) has projected growth of 6.6% for 2026-27, while flagging that elevated oil and commodity prices, along with weaker global growth, remain downside risks.

·         Inflation has crept up. Headline inflation rose from 3.5% in April 2026 to 3.9% in May 2026 on the back of oil pass-through. A combination of the conflict-driven supply shock and a projected weak monsoon due to El Niño could push inflation toward the upper end of the tolerance band in Q3:2026-27 — the MPC has already revised its inflation projection for 2026-27 upward, from 4.6% to 5.1%.

·         The balance of risks has actually turned more favorable. This is credited to the interim peace deal in West Asia along with recent Government and RBI measures aimed at strengthening capital inflows — even as some impact from India’s dependence on imported energy remains unavoidable.

·         Capital flows have come under pressure. Net FDI flows turned muted amid rising global uncertainty, and net international investment position dynamics reflect the broader retreat in capital allocated to emerging markets during the conflict period.

Indian equity markets

·         Indian equities underperformed EM peers, then corrected further. Trailing its emerging-market peers for over a year, the domestic equity market fell further amid concerns about India’s exposure to the oil-price shock and a resulting softening in corporate earnings growth. India’s earnings-growth differential over EM peers has now dropped below its long-term average.

·         FPIs sold at a scale not seen in over two decades. FPI equity outflows of US$ 30.7 billion in 2026 exceeded the prior record of US$ 18.9 billion set in 2025 — the highest outflow observed in the past two-and-a-half decades. FPI ownership of Indian equities has fallen to a two-decade low, and for the first time is now below that of domestic institutional investors (DIIs).

·         Domestic investors were the shock absorbers. Despite the sharp correction, the 5-day worst-drawdown in Nifty 50 during this episode was the mildest across comparable crisis periods studied by the RBI, thanks in large part to rising support from mutual funds, insurers and pension funds.

·         The Nifty 50 rally of the last two years has partly unwound. A returns-decomposition exercise (Gordon Growth Dividend Discount Model) shows that between September 2024 and June 2026, a rising equity risk premium — reflecting heightened investor risk aversion — has eaten into the gains that were earlier driven by risk-premium compression. The correction has, at least, brought valuations closer to their historical average, even though Indian equities continue to trade at a premium to EM peers.

Financial system stress in India

·         The stress indicator ticked up, but stayed low by historical standards. The Financial System Stress Indicator (FSSI) rose during the conflict period, but the level of stress in the domestic financial system remains relatively low compared to previous crisis episodes.

·         Banks are in their best shape in decades. Scheduled commercial banks (SCBs) remained resilient, with the gross non-performing assets (GNPA) ratio falling to a multi-decadal low of 1.8% in March 2026 and the net NPA (NNPA) ratio at 0.4%. Return on assets (RoA) stood at 1.3% and return on equity (RoE) at 12.6%, while the capital to risk-weighted assets ratio (CRAR) and common equity tier 1 (CET1) ratio stood at 17.7% and 15.3% respectively — both comfortably above regulatory minimums. Credit growth accelerated to 14.5% y-o-y and deposit growth to 11.5% y-o-y during 2025-26.

·         Stress tests say the buffers can take a hit. Macro stress test results indicate that the banking system remains well-positioned to absorb potential shocks, with aggregate capital ratios projected to stay comfortably above regulatory thresholds even under hypothetical adverse scenarios.

·         NBFCs and other intermediaries also pass the test. Non-banking financial companies (NBFCs) remained financially sound, supported by strong capitalization, healthy profitability and improving asset quality. Stress tests of mutual funds, clearing corporations and the insurance sector similarly point to continued resilience, even as rising interconnectedness across entities and sectors is flagged as a channel that merits close surveillance.

The moot point in FSR is whether India’s buffers — strong bank balance sheets and resilient domestic flows — are enough to keep absorbing repeated external shocks without the strain showing up in the real economy. On the RBI’s own assessment, so far, they have.

FCNR(B) – What does this domino effect mean for banks

(Continuing from yesterday…see here)

The implications of a successful FCNR(B) campaign for the banking sector are far-reaching.

First, and most directly, FCNR(B) deposits will not attract CRR or SLR requirements on the incremental amounts. This is not a new concession — the same dispensation applied in 2013 — but it means that every dollar raised through this route translates almost entirely into deployable liquidity. A $40 billion inflow, at a spot rate of approximately Rs 93-95 per dollar, would inject Rs 3.7-3.8 lakh crore into the system. This is a very large number. For context, the entire banking system’s liquidity deficit through most of early 2025 was in the range of Rs 1.5-2 lakh crore.

Second, the scheme addresses the CD ratio problem in a way that domestic deposit mobilization efforts cannot quickly replicate. NRI deposits are not cannibalizing domestic savings — they represent an external infusion. Banks that succeed in raising substantial FCNR(B) deposits could see their CD ratios ease meaningfully, reducing the pressure to offer higher domestic deposit rates and thereby protecting net interest margins.

Third, as one analyst report aptly noted, successful mobilization “should have a sobering effect on loan pricing and other market-based yields across commercial papers, certificates of deposit, and government securities, helping in true transmission.” Put simply, additional liquidity should reduce the cost of credit across the economy — something that rate cuts alone have struggled to deliver in a tight liquidity environment.

Fourth, the scheme provides a measure of protection against wholesale deposit instability. When a bank can replace jumpy institutional deposits with longer-tenor (three to five year) NRI money, the structural fragility of its liability side reduces meaningfully.

The BoP dimension: Managing the external account

The FCNR(B) scheme is as much an external account management tool as it is a banking sector liquidity measure. India’s balance of payments position is at risk of marked deterioration. The current account deficit could widen on account of sustained elevated crude oil prices and widening trade deficit with major partners. Simultaneously, Foreign Portfolio Investment (FPI) flows into Indian equities turned volatile and net negative through significant portions of FY26, as global investors rotated away to developed markets and other emerging markets.

The rupee, consequently, bore the brunt. Having crossed 90 against the dollar in early 2026 and continuing to slide toward 94-95 in subsequent months, the currency’s weakness threatened to become self-reinforcing through imported inflation, higher oil import bills, and corporate balance sheet pressures for those with unhedged foreign currency liabilities.

The RBI has been intervening, but at a cost. Since February 2026 alone, over $38 billion of foreign exchange reserves were deployed to cushion rupee depreciation — drawing down reserves from their peak of $728.49 billion. At $681-682 billion, reserves remain substantial (covering approximately 11 months of merchandise imports, per the RBI Governor), but the rate of attrition is a concern.

The FCNR(B) inflows would replenish that buffer without requiring the RBI to buy USD in the open market. In effect, the scheme converts long-term NRI savings into a direct reserve-building exercise — a far more durable source of forex inflows than short-term portfolio capital. In 2013, the $34 billion raised through FCNR(B) was widely credited with stabilizing the rupee and turning the BoP position around. The hope is for a similar impact, though the quantum and speed of inflows will determine the ultimate efficacy.

The 2013 Comparison: What is different this time

The 2013 FCNR(B) episode under Raghuram Rajan is rightly remembered as a masterclass in crisis management. Within weeks of the announcement, market sentiment turned, the rupee stabilized, and $34 billion flowed in — far exceeding initial expectations. But 2026 is not 2013, and a few important differences merit attention.

In 2013, the episode was triggered by a single, identifiable shock — the Fed’s taper tantrum. Once the global environment stabilized and the RBI acted decisively, confidence returned quickly. The current challenge is more diffuse: a mix of geopolitical risks (the West Asia war and its oil price consequences), US tariff uncertainty, structural domestic demand softness, and a banking system that is adjusting from a period of unusually high credit growth. There is no single event to “catch.”

Additionally, while NRI depositors have always been rate-sensitive, the global interest rate environment today offers them competitive alternatives that did not exist in 2013 in the same way. US Treasury yields, for instance, remain elevated. The deposit and lending rates in countries like the US, the UAE, and Singapore are also much higher as compared to 2013. The spread offered by FCNR(B) deposits may not be compelling enough to overcome home country inertia and alternative opportunity costs.

Finally, the RBI’s hedging cost today — borne at approximately 2.9% per annum — represents a meaningful cost to the central bank’s balance sheet and, by extension, to its future surplus transfers to the government. If $40-50 billion is raised, the annual hedging cost borne by the RBI could be in the range of $1.2-1.4bn. That is not a prohibitive number given the BoP stability it purchases, but it is not insignificant either, if we consider that the annual budget of ISRO is US$1.4bn.

Another point to be noted is that in 2013 most of the incremental FCNR deposits were used to augment the reserves. Besides, other measures, e.g., reduced LSR remittance limits, were also used to limit the outflows. This time, much of the incremental deposits could just end up replenishing the FII and Net FDI outflows.

Investment Implications: What Should the Analyst Track?

For investors in Indian banking stocks, the emerging picture suggests a period of transition rather than resolution. Several themes are worth tracking.

On the positive side, if FCNR(B) inflows are substantial — say in excess of $30bn — the banking sector will be a meaningful beneficiary. System liquidity improvement will reduce reliance on expensive wholesale deposits, compress deposit costs, and allow for better NIM protection. Banks with stronger NRI relationships and international banking capabilities — notably the larger private sector banks and SBI, which has an extensive overseas network — may be better positioned to capture these flows.

The rupee stabilization effect, if it materializes, will reduce the import cost burden for the economy broadly and ease inflationary pressures, which would in turn support the RBI’s ability to maintain accommodative monetary conditions.

On the risk side, investors should remain cognizant that the FCNR(B) scheme creates a large matured liability for banks for three to five years hence. When these deposits mature — between 2029 and 2031 — the banks must return the foreign currency. If India’s external account is under stress at that point, the rollover risk could be significant. This is precisely what happened when the 2013 FCNR(B) deposits matured in 2016: the RBI had to manage a significant outflow, though it did so without incident. The lesson is that today’s relief is tomorrow’s contingent liability.

The fiscal trajectory remains a key watch item. A government that continues to miss its tax revenue targets while facing disinvestment underperformance will compete with the private sector for available savings — keeping yields higher than they otherwise would be and limiting the NIM upside from liquidity improvement. Resolution of the fiscal challenge is a necessary condition for a durable easing of banking sector stress, not a sufficient one in isolation.

FCNR(B) inflows – the likely scenario

Most large banks have announced rates for 3-year FCNR(B) deposits in excess of US$1mn in the range of 6-6.15%. Some smaller banks have even offered 7%.

The actual inflows would largely depend on the domestic credit franchise (how much of the mobilized USD it can lend/sell under LRS to the domestic borrowers) of the mobilizing banks.

The actual deal is the NRI depositor borrows from the overseas banks and deposits as FCNR(B) with an Indian branch.

The rate of lending to the depositors would depend on one-month SOFR and 3-year interest rate swap, expected credit cost provision and profit margin for the bank. Considering a 19x leverage (5% margin), the net return to the depositor could be in the range of 13-15% p.a. on the principal amount invested.

Conclusion

RBI, facing a multi-dimensional challenge — banking liquidity, currency weakness, BoP stress — has done well to use a time-tested measure. The FCNR(B) scheme could addresses all three simultaneously, while supplementing it with USD/INR swaps that ease domestic liquidity without burning down reserves. This is not panicked firefighting; it is deliberate central banking.

The banking sector will benefit, but investors should resist the temptation to extrapolate from 2013. The structural challenges that created the problem — a financializing household saving base that increasingly prefers non-bank instruments, a fiscal deficit that crowds and constrains, a growth model that generates more credit demand than the deposit base can organically support — will not dissolve with a single scheme, however well-designed.

The CD ratio will ease. The wholesale deposit overhang will moderate. Liquidity conditions will improve. But the medium-term question — how India’s banking system funds a $5 trillion economy when households are increasingly choosing the mutual fund and corporate debt over the fixed deposit — remains open. That is the question the banking sector and its regulators will have to answer over the coming decade, one policy measure at a time.

Also Read

How the Indian financial sector is navigating a perfect storm

 

Hope Fading, Prices Rising

The Reserve Bank of India (RBI) recently released the results of its latest forward-looking surveys (May 2026 Round). Based on the feedback received from respondents, the survey results provide important insights with respect to consumer confidence — both urban and rural — inflationary expectations and economic growth expectations from professional forecasters.

Urban Consumer Confidence – A third successive decline

Consumer confidence for the current period declined for the third successive round, with the Current Situation Index (CSI) falling sharply to 90.7 from 95.7 in the previous round. A value below 100 indicates a state of pessimism, and on this measure, urban households are now firmly in negative territory on their assessment of present conditions.

The deterioration is broad-based. Perceptions on the general economic situation worsened considerably — the net response on economic conditions fell by 7.9 points to -16.5, as nearly 48% of respondents felt conditions had worsened compared to a year ago. Sentiment on employment also deteriorated sharply, with the net response on employment falling to -14.4 from -9.1 in the March 2026 round. Income perceptions barely stayed positive, with a net response of just 0.9.

The forward-looking Future Expectations Index (FEI) also weakened, dropping 1.5 points to 118.7 — the lowest reading since September 2023. While the index remains in optimistic territory (above 100), the trajectory is concerning. Households have revised down their expectations on economic situation, employment, income and spending across both time horizons. The waning of confidence is primarily driven by ebbed sentiment on discretionary expenditure, with non-essential spending expectations falling sharply: the net response on future non-essential spending collapsed to 15.9 from 21.1 in the previous round.

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Rural Consumer Confidence – Similarly Strained

Rural confidence tells a similar story. The Current Situation Index (CSI) for rural households fell further to 95.2, declining for the second successive round from a recent peak of 100.9 in September 2025 — a fall of nearly 6 points over three survey rounds. Current perceptions on the economic situation moved into negative territory (net response of -2.5), and employment sentiment also turned negative (-1.2). Income perceptions remain weak at -5.8.

The Future Expectations Index (FEI) for rural households fell sharply to 119.3 from 125.1 in March 2026, with worsening conditions across all parameters except prices. Forward expectations on income fell to a net response of 38.9, down from 45.7. Spending expectations also softened notably, with non-essential spending expectations falling to a net response of just 42.6, from 59.5 in the previous round — a significant pullback suggesting rural households are tightening their belt.​

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Household Inflation Expectations – Rising Sharply

Urban households’ current median inflation perception jumped by 60 basis points (bps) to 7.8% compared to the previous round. Inflation expectations for the next three months and one year both edged up by 80 bps and 50 bps respectively, reaching 9.3% for both horizons. The proportion of respondents anticipating higher prices inched up across all product categories, with food products, non-food products and housing all seeing increased price pressure expectations.

The rural picture is consistent. Median inflation perception among rural households rose by 30 bps to 5.9%, and one-year-ahead inflation expectations climbed 40 bps to 7.2%. Across age and occupation groups, the upward drift in inflation expectations is widespread — particularly notable among retired persons, who now expect inflation of 8.6% over the next year.

Professional Forecasters – GDP revised down, inflation revised up

GDP: Real GDP is now expected to grow at 6.5% in FY27, revised down by 40 bps from the previous round. For FY28, the forecast stands at 6.9%, modestly lower by 10 bps. Forecasters have assigned the highest probability to GDP growth in the 6.5-6.9% range for FY27, while for FY28, the modal outcome is also the same band. Annual growth in real PFCE and GFCF for FY27 are expected at 6.8% and 6.5% respectively, with GFCF revised down by 60 bps — a signal of tempered capital formation expectations.

Real GVA growth for FY27 is pegged at 6.6%, with services (7.7%) and industry (6.8%) doing the heavy lifting, while agriculture is expected to contribute a modest 2.4%.

Inflation: This is where the story turns uncomfortable. Annual headline CPI inflation is expected at 4.9% for FY27 and 4.5% for FY28. The quarterly path, however, reveals a more concerning picture: CPI is forecast at 4.0% in Q1 FY27, rising to 4.9% in Q2, accelerating to 5.5% in Q3, and easing only marginally to 5.2% in Q4. Core CPI (excluding food and fuel) is expected to rise from 3.9% in Q1 to between 4.4-4.7% through the rest of the year.

WPI inflation forecasts have been revised up sharply. WPI All Commodities is projected at 8.9% in Q1 FY27, 9.0% in Q2, before moderating to 7.9% in Q3 and 6.5% in Q4.

External Sector: Merchandise exports are expected to grow 5.0% in FY27 and 4.7% in FY28 in US dollar terms. Imports, however, are forecast to grow much faster at 10.5% in FY27, before normalizing to 4.6% in FY28. This asymmetry pushes the current account deficit (CAD) to 2.1% of GDP in FY27 — a significant deterioration of 60 bps from the previous round’s estimate — narrowing to 1.2% in FY28. The median USD/INR rate is pegged at around 95.4-96.6 across the quarters of FY27, with crude oil (Indian basket) expected in the $85-105/barrel range across quarters.

The takeaway

Taken together, the May 2026 round of RBI’s surveys paints a picture of an economy that is growing at a reasonable but moderating pace, against a backdrop of rising inflation pressures and rapidly eroding consumer confidence — across both urban and rural India.

The triple squeeze is hard to miss: households feel worse off today than a year ago, they expect prices to be significantly higher a year from now, and they are pulling back on discretionary spending. Professional forecasters have simultaneously marked down growth and marked up inflation. The widening CAD and sharp upward revision in WPI forecasts add to the headwinds.

Hope was the dominant sentiment in previous survey rounds. In this one, it is fading. The optimism that characterized forward expectations — buoyant FEI readings, resilient income outlook, strong discretionary spending intentions — is giving way to something more sober. If the quarterly CPI trajectory plays out as forecast, with inflation touching 5.5% in Q3 FY27, the RBI will face an uncomfortable policy tradeoff, even as growth edges lower.

For investors, the signposts are clear enough: demand recovery may disappoint consensus, margin pressures from higher input costs are likely to persist, and the consumer staples vs discretionary divide may widen further. The surveys may not move markets directly, but they sharpen the lens through which to read the earnings season ahead.

 

Markets in a state of disbelief

“Markets stop panicking when the authorities begin to panic.”

The logic behind this old adage is intuitive: in a sudden crisis, financial markets typically price in the worst-case scenario well before governments, central banks, and regulators even acknowledge the problem. Once the authorities do act — through stimulus, rate cuts, liquidity injections, or other interventions — the corrective measures tend to limit the actual damage, providing an immediate floor and often a sharp rebound to stock prices that had already discounted catastrophe.

Empirical evidence

1990 — Balance of Payments Crisis: Fuelled by fiscal deficits, dwindling foreign reserves, and the Gulf War oil shock, India was pushed to the brink of sovereign default. The government’s eventual response — including pledging gold reserves and accepting an IMF bailout — marked the beginning of India’s landmark economic liberalisation. Markets recovered.

1998 — Asian Financial Crisis Contagion: Contagion from the 1997 Asian Financial Crisis rattled the rupee and slowed growth. Tight monetary policy and fiscal prudence steadied the ship.

2008 — Global Financial Crisis: The collapse of Lehman Brothers triggered a sharp stock market crash and industrial slowdown. A coordinated response of fiscal stimulus, rate cuts, and liquidity injection arrested the fall.

2013 — Rupee and Current Account Crisis: A widening current account deficit combined with US Federal Reserve tapering signals drove the rupee to ₹68/USD with inflation surging. The RBI’s decisive rate hikes and forex market interventions restored confidence.

2020 — COVID-19 Pandemic Shock: Nationwide lockdowns contracted GDP by an estimated 7.3%. But aggressive fiscal support (PMGKY), RBI liquidity measures, and deep repo rate cuts helped markets stage one of their sharpest recoveries on record.

In each case, the pattern held: authorities panicked (or at least acted decisively), and markets calmed.

The latest episode

The Indian economy is navigating a confluence of serious headwinds. The India-Pakistan military stand-off in May 2025 rattled investor sentiment. Sweeping changes to US tariff and immigration policy, which began taking effect through 2025, disrupted trade flows and created uncertainty for Indian exporters and the IT-services sector. An escalating conflict in West Asia — with implications for oil prices, remittances, and regional stability — has added another layer of risk as of early 2026.

Financial markets have responded accordingly, and painfully. Bond yields have risen sharply. The rupee has weakened significantly, ranking among the worst-performing major currencies over the past year. Equity markets have corrected meaningfully — the Nifty 50, which stood near 23,465 in mid-2024, has gone essentially nowhere in two years, even as several peer markets have advanced. Indian equities have strikingly underperformed comparable emerging markets.

So far, this fits the familiar script. Market pricing in the worst.

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The adage is being tested

The Prime Minister has, in recent public statements, signaled growing concern about the economic situation — a rare and telling departure from the usual official optimism. The RBI Governor has similarly struck a more cautious tone. In other words, the authorities appear to be beginning to panic.

By the logic of the old saying, this should be the inflection point. Markets should be bottoming out. Relief should be setting in.

And yet — the panic in markets is not subsiding.

Why are markets in a state of disbelief?

Is it that investors doubt the adequacy of the policy response? Is the nature of this crisis — multi-front, geopolitical, and partly beyond India’s control — fundamentally different from past ones? Or is something else at work?

…more on this next week