India has attracted a much larger-than-anticipated $136.38 billion in foreign currency inflows through special financing programmes, providing the Reserve Bank of India (RBI) with greater capacity to protect the rupee from external pressures.
The inflows were generated through measures introduced in June, when a sharp increase in oil prices threatened to push India’s balance of payments into deficit. The schemes were designed to bring in relatively stable dollar funding as India’s import costs climbed amid supply disruptions associated with the U.S.-Iran conflict.
The RBI said the largest contribution came from its programme encouraging non-resident Indians to place foreign currency deposits with Indian banks. The scheme generated $127.23 billion, substantially exceeding economists’ earlier expectations of between $80 billion and $90 billion.
Indian banks also raised $3.89 billion through external commercial borrowings and another $5.26 billion through overseas foreign-currency borrowings. Together, these sources accounted for the $136.38 billion total reported by the central bank.
India has repeatedly relied on its overseas diaspora when the domestic currency comes under pressure. In such situations, authorities have offered incentives, including lower hedging costs, to encourage Indians living abroad to bring dollars into the country’s banking system. A similar programme launched in 2013 generated approximately $26 billion.
The latest response was considerably larger. Vivek Rajpal, Asia strategist at JB Drax Honore (UK), said the scale of the inflows was well above expectations and should provide the RBI with greater confidence in managing currency volatility.
The strong response also helps explain why the central bank ended the foreign-currency deposit programme ahead of schedule. The facility had initially been due to remain available until the end of September, but the RBI closed it on August 31 after deposits surged. A separate programme permitting banks to raise funds overseas remains active.
## Stronger Foreign Exchange Reserves
The dollars collected through the deposit programme are exchanged by participating banks with the RBI, meaning the funds directly increase India’s foreign exchange reserves.
Those reserves had already climbed to a record $729.33 billion in the week ending August 21. The additional dollar liquidity gives the central bank more resources to respond to pressures created by elevated oil prices and higher U.S. Treasury yields.
Currency traders said the RBI had increased its dollar sales in recent days as it sought to support the rupee. The fresh inflows therefore provide additional resources for the central bank as it manages movements in the currency market.
However, the programmes also create obligations for the future. The dollars raised through the schemes must eventually be returned, meaning the immediate improvement in foreign exchange availability comes with a corresponding repayment responsibility for the RBI.
That future liability was already visible in the central bank’s foreign exchange forward position, which rose to a record $136.7 billion in July as foreign currency deposits increased. Much of the money raised through the programme is committed for periods ranging from three to five years.
Macquarie warned that although the inflows deliver an immediate and substantial funding advantage, allowing them to grow without limits could eventually create a concentrated repayment burden and contribute to greater currency volatility when the funds mature.
## Liquidity Challenge for Indian Banks
The surge in dollar inflows is also affecting liquidity within India’s banking system. When the foreign currency raised by banks is exchanged with the RBI, the transaction injects rupee liquidity into the financial system.
That presents another challenge because Indian banks are already holding substantial surplus cash. If the additional rupee liquidity remains in the system, it could potentially contribute to inflationary pressures.
Siddharth Kothari, an economist at Sunidhi Securities, said the unusually large amount of U.S. dollar liquidity entering the banking system over a relatively short period could make it necessary for the RBI to sterilise the resulting rupee surplus.
One possible approach would involve temporarily raising the Incremental Cash Reserve Ratio (ICRR), followed by a more lasting liquidity-management measure through a higher Cash Reserve Ratio (CRR), or a combination of the two.
Banks are required to keep a specified portion of their deposits as reserves. However, the funds raised through the special foreign-currency deposit programme were exempt from those reserve requirements.
The latest inflows consequently provide India with a stronger immediate external funding position and greater capacity to defend the rupee, while also presenting the central bank with the task of managing excess domestic liquidity and future repayment commitments.
