Assume that a non-resident Indian (NRI) takes a 162 million yen loan at, say, 4% interest per annum and converts it to $1 million. This amount can then be put in a foreign currency non-resident (FCNR) deposit at an interest rate of, say, 6.5% for 3 or 5 years.
The bank gives these dollars to the Reserve Bank of India (RBI), which in turn swaps them without any risk premium. This means that the bank can buy back the dollars at the present exchange rate at the time of maturity. Sounds good? Yes, this is how carry trade works, but the difference is that banks would normally not pay such high rates of interest, given the foreign exchange risk they bear, as reflected in the forward hedging rate of around 3%.
The rupee has depreciated by an average 3% per annum over the past decade, which usually prevents such arbitrage and explains why banks had kept their FCNR deposit rates low. But with RBI now taking on the cost of an exchange-rate hedge, banks can safely offer high rates on NRI dollar deposits.
An NRI can borrow in any currency and convert it to dollars, but funds are cheapest in Japan. In the US, the cost of such loans can start from 6%, thus offering little scope for a net positive return.
Borrowing in yen is far more attractive, but it entails the risk of yen appreciation. If that happens, returns could diminish or be in jeopardy. The yen has depreciated by almost 4% per annum from 109 per dollar before covid to around 162 now. This looks too sharp. Hence, it could possibly strengthen over the next 3-5 years.
The use of leverage to invest in FCNR deposits is the idea’s big appeal. Otherwise, flows into these deposits have been lacklustre. The last time such a scheme was drawn up, with a fixed swap rate offered by RBI, was back in 2013-14 when the forwards rate was almost double. From $15 billion in 2012-13, deposits jumped to $41 billion in 2013-14, but had declined to $34 billion by 2025-26.
Two factors explain this. First, RBI’s special incentive was time-bound for those working on leverage. Second, non-leveraged deposits offer limited buoyancy as interest rates are continuously compared with local rates by prospective depositors.
Estimates of what RBI’s latest scheme can draw vary from $40 billion to $100 billion amid euphoria over it being a win-win game: NRIs get higher returns than what they would earn in their country of residence, while banks get liquidity when they exchange dollars with RBI at a cost that is lower than of domestic funds (with RBI’s zero-return cash reserve and statutory liquidity mandates thrown in).
On its part, RBI gets to shore up its foreign exchange reserves—the swap cost does not really matter for a central bank. As a collateral gain, the dollars swapped for rupees with RBI leads to an infusion of liquidity into the system, thus helping address a shortfall in local deposits for on-lending. This is already showing in a decline in certificate-of- deposit rates.
An interesting question that arises is whether the scheme could have been extended to all investors and not just NRIs. This would have helped widen the universe of potential investors and could have been called a special foreigner deposit programme.
Another pertinent question is what happens after 3 or 5 years when these deposits have to be redeemed. While inflows of $40-100 billion are large, these can prove onerous if not renewed on maturity. Else, India’s current account would have to support these flows.
On the capital account side, inflows of foreign direct investment (FDI) and from foreign portfolio investors (FPIs) need to strengthen and turn significantly positive. Here, the ‘FDI syndrome’ is relevant—a situation we have faced for the last few years where gross inflows have risen to almost $100 billion, but repatriations have increased too, thus resulting in unimpressive levels of net FDI.
Several investors who invested in enterprises have moved out. Some have used initial public offerings as a way to take money out of India. A similar worry can arise for FCNR deposits when they are due for redemption.
Interest rates in source countries could move over the next 3-5 years, with currency movements also hard to predict. All those taking loans right now to invest in FCNR deposits would have to estimate their risk when it is time to pay back.
Retail investors would not re-deposit the money if interest rates are cut. So India would have to keep a large stash of dollars available for FCNR redemptions. It would impact the country’s foreign exchange reserves, which would dip by a matching amount.
The central bank has been using buy-sell foreign exchange swaps to infuse greater liquidity into the system. So far in 2026, it has already bought $25 billion from banks that will fall due after three years.
As these swaps are part of its liquidity management framework, there is a possibility of more such swaps taking place in the future. Therefore, it is important to monitor all these flows even as we hope that other components of India’s balance of payments would turn largely positive over the next 3-5 years.
It will be useful to build suitable buffers for foreign exchange reserves to enable the smooth redemption of NRI deposits when the time comes. One can be sanguine that moves made by the government on the trade front, especially its new set of agreements, will bring about a substantial improvement in India’s current account balance. The economy’s growth story must continue to resonate with foreign investors.
These are the author’s personal views.
The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’