RBI's 'Debt Wish' Will Make India's Forex Reserves More Precarious Going Forward

The RBI has announced several measures to attract more foreign debt into India. Subhash Chandra Garg breaks it down.

The government and the RBI are willing to take on more debt ostensibly to prevent further erosion in forex reserves and to provide a safety belt to the rupee exchange rate. 

(Photo: Kamran Akhter/The Quint) 

On 5 June, the government and the Reserve Bank of India (RBI) announced a slew of measures targeted at attracting more foreign debt into India.

This included a tax exemption on foreigners’ investment in government securities; the RBI bearing the full hedging cost for banks raising Foreign Currency Non-Resident Bank (FCNR[B]) deposits; and subsidising the hedging cost for external commercial borrowings (ECBs) raised by public sector enterprises.

There has been significant pressure on India’s foreign exchange reserves, resulting in massive depreciation of the rupee against the US dollar of more than 12 percent in the last year. The government and the RBI are willing to take on more debt ostensibly to prevent further erosion in forex reserves—and to provide a safety belt to the rupee exchange rate. 

Conspicuously, no measures, barring a token effort permitting Persons Resident Outside India (PROI) to invest in India’s listed companies and a pro forma increase in the overall investment limit from 10 to 24 percent, have been taken for boosting foreign investment.

Is there a panic in the government and the RBI rushing for more debt? Will these measures trade prudential safeguards for risky foreign debt inflows? Will there be a flood of debt inflows? Will it secure India’s foreign reserves and external stability or make it more vulnerable?

India’s Foreign Debt and Targeted Constituents

India’s outstanding foreign debt liabilities amounted to $765.5 billion on 31 December 2025, as per the quarterly external debt report of the Ministry of Finance. India’s total external liabilities on that date were $1,458.51 billion and external assets $1,198.02 billion (including forex reserves of $687.43 billion), as per the RBI's Quarterly International Investment Position data released in May 2026.

India’s foreign debt exceeded India’s total forex reserves by 11 percent and other assets ($510.6 billion) by about 50 percent. India’s foreign debt is quite high with respect to its external reserves and assets.

Over the years, India’s external debt has become heavily non-governmental (commercial and banking), rising to $596.8 billion (about 78 percent of the total debt of $765.5 billion).

Banks owed $202.7 billion; non-banking financial corporations (Power Finance Corporation or PFC, EXIM, and so on) $75.7 billion; commercial enterprises and businesses $281.6 billion; and inter-corporate borrowings $36.8 billion.

Non-government external debt constitutes 86.8 percent of India’s forex reserves and exceeds 16 percent of India’s GDP. There are no firm estimates of PSUs' outstanding external debt. My estimates are about 5 percent of commercial debt ($14 billion) and 50 percent of non-bank financial corporations ($37 billion). In all, about $50 billion.

NRI deposits ($165.7 billion on 31 March 2026) make up the bulk of banks’ external liabilities. FCNR(B) deposits, targeted by the RBI's decision to bear full hedging cost, at $33.76 billion make up about 20 percent of the total NRI deposits. The Non-Resident External [NR(E)] Deposits, which are also freely repatriable and exempt from income tax like FCNR(B) deposits ($98.56 billion), are larger and make up 60 percent of the total deposits. The NR(E) depositors bear foreign exchange risk. The RBI announced no support for NR(E) deposits.

Foreigners’ investment in government securities is made in rupee (they also bear full exchange risk) and is not counted in India’s foreign debt liabilities. At the end of December 2025, the FPIs held 2.96 percent of outstanding central government securities of Rs 123.94 trillion, or about Rs 3.66 trillion ($38 billion at Rs 96 to a US dollar).

The 5 June debt measures target flows, which currently amount to about 85 billion of foreign debt [PSUs and FCNR(B) deposits] and 38 billion of government securities. 

Bet on Government Securities Unlikely To Succeed

Many factors enter into FPIs’ decision to invest in central government securities:

• Interest rate differences between what India pays and what they can earn on US securities of comparable tenor.

• Rupee depreciation partly managed by hedging (typically available for short periods, whereas interest flows and repayment are long-term).

• And income tax payable on interest (there are negligible capital gains). 

The FPIs have been reducing their exposure in government securities since 2018. The inclusion of Indian bonds in two emerging market global bond indices had revived their interest to some extent from 2024. In the last six months, the FPIs, however, have been net sellers (net reduction $0.3 billion in 2025-26). 

The amendment to the Income Tax Act, 2025 to exempt FIIs, which are predominantly FPIs, from income tax on interest and capital gains impacts only one of the considerations. This will also benefit only the FIIs/FPIs from countries which do not have a double tax avoidance agreement (DTAA) or have not been given specific tax exemptions. This universe may not exceed 25 percent of the total FPI investments in government securities.

The RBI is also streamlining the FPI regime by removing many irritants (many quotas and sub-quotas, concentration limits, no investment in short-term securities, etc) on a mechanism termed the 'general route'. These measures make the general route more akin to the other route—the fully accessible route (FAR), which accounts for about 85 percent of FPIs’ investment in government securities.

The RBI measure is largely pro forma, and not going to make any difference. The RBI may as well abolish the general route. 

The income tax exemption is unlikely to make much difference and might not bring even an additional $5 billion if the rupee depreciates more than 3-4 percent in the rest of 2026-27. It will also leave Indian investors unhappy at discriminatory treatment as they remain subject to income tax.

Hedging Subsidy Will Damage PSUs' Credit Rating

The PSUs—both financial (SBI, PFC, EXIM Bank, etc) and non-financial (Indian Oil, ONGC, etc)—raise external debt in many formats like ECBs, trade credit, corporate bonds, etc. The borrowing needs of the oil sector and fertiliser PSUs have gone up sharply after the breakout of the US/Israel-Iran war.

The RBI hedging subsidy of 1.5 percent for borrowings up to 30 September will encourage the PSUs (both financial and non-financial) to rush to raise ECBs, bonds, and trade credits by offering up to a 1.5 percent higher interest rate than they were doing thus far. As Indian PSUs are proxy sovereigns, the foreigners may not resist the temptation of earning up to 1.5 percent extra interest.

This will raise India’s external borrowing cost, including other borrowers (in the private sector, not accorded the favour) who may also have to raise interest payable on their external borrowing. 

There is also prudential distortion in domestic financial markets, as this measure essentially shifts the hedging cost from the PSUs’ balance sheet to the RBI balance sheet. The PSUs’ borrowings after 30 September may also become more uncertain. 

Depending upon the efficiency of PSUs, they may raise an additional $10-15 billion in debt, which is subsidised for them but costlier for the nation. 

FCNR(B) Deposits Hedging Subsidy Is Pernicious

The RBI will bear the full hedging cost on FCNR(B) deposits. The measure alters incentives for both the banks and the NRIs. A great FCNR(B) rush has begun. There are various estimates floating around—$50 billion and higher.

The banks can now offer an interest rate as high as their cost of rupee borrowing as the difference between their rupee and foreign currency borrowing vanishes. The banks have announced schemes for accepting FCNR(B) deposits at 6 percent (some going up to 7 percent). They were paying 3-3.5 percent interest on FCNR(B) deposits earlier. 

The NRIs have two big opportunities. First, they can make new FCNR(B) deposits, as they would be able to earn higher interest than they are getting for their deposits abroad (including by taking loans at a lower effective cost). Second, they can convert their NR(E) deposits into FCNR(B) deposits as interest spread between the two schemes disappears. 

Interest rates are going up abroad. Recently, the US Treasury paid about 5 percent interest on a 30-year bond, and deposits of 3-5 years are getting interest in excess of 4 percent. Extra interest on FCNR(B) deposits is about 2 percent—large enough but not as big as in 2013. Conversion of NR(E) deposits appears to be clearly attractive. The NRIs can keep their dollars and get interest payable on rupee deposits.

It is difficult to figure out how exactly the NRIs will behave. As things stand today, it looks likely that the FCNR(B) deposits might go up to about $100 billion (from $34 billion), with fresh inflows amounting to about $25-30 billion. 

The move on FCNR(B) deposits is quite a dangerous one. In one sweep, the RBI has removed the distinction between rupee and dollar liabilities on NRI deposits for the banks and the country. This positions India and Indian banks as much poorer credits, besides significantly raising India’s interest servicing cost. 

A Fatal 'Debt Wish'

It has been a core part of India’s prudential external debt management that the businesses and banks bear the full cost of borrowing abroad, including currency risk or its hedging cost. This makes their incentives fully aligned to their real cost of external borrowing, tempering a rush for foreign borrowings to take advantage of the interest rate differential between rupee and foreign currency borrowings. 

The government and the RBI, by taking currency risk hedging cost out of the prudential debt management toolkit, has distorted credit markets and made India, banks, and businesses tempted to binge on foreign debt recklessly. 

The fact that the government and the RBI ignored foreign investment completely and focused on raising easy and costly debt only indicates their lack of faith in India’s long-term growth story and foreign reserves and financial sector stability.

Their "debt wish" will make India’s external investment account and foreign exchange reserves more precarious going forward, making it a fatal attraction.

(Subhash Chandra Garg is the Chief Policy Advisor, SUBHANJALI, and Former Finance and Economic Affairs Secretary, Government of India. He's the author of many books, including 'The $10 Trillion Dream Dented, 'We Also Make Policy', and 'Explanation and Commentary on Budget 2025-26'. This is an opinion piece, and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)