'External debt could rise to $900 bn': RBI's FCNR(B) move has created five major risks, warns ISB professor

Prasanna Tantri, associate professor of finance at the Indian School of Business, has warned that the Reserve Bank of India's measures to support the rupee through FCNR(B) deposits and other foreign-currency borrowing have created five major risks for the Indian economy.

"The FCNR(B) saga has ended," Tantri said in a post on Thursday. Together with external commercial borrowings (ECBs) and other foreign-currency borrowing, India has mobilised roughly $136 billion in borrowed dollars to defend exchange-rate levels, he said.

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Tantri estimated that India's external debt could consequently rise from about $765 billion to nearly $900 billion.

He also flagged the impact on domestic liquidity. The effort to prevent a quick appreciation of the rupee has left the banking system with about ₹7.7 lakh crore in surplus liquidity, or reserve money, he said. That is close to the Covid-era peak of ₹9.5 lakh crore.

Unlike during the Covid, however, the expansion in reserve money has happened while the economy is growing strongly, the professor said. He added that the RBI has “effectively guaranteed the future rupee value” of much of this money.

Why Tantri Calls It A Risk

Tantri said financial decisions should be assessed before their outcomes are known. "Not every risky decision ends in disaster, but escaping disaster does not justify taking an unnecessary risk," he said.

He rejected the argument that the rupee was facing a "run". A roughly 10% real depreciation, alongside about $650 billion in reserves, strong remittances, and a near-zero current-account deficit, did not amount to a run, he said.

Even if there had been a run, Tantri argued that borrowing against a future guarantee should not have been the first line of defence. "No doctor will ever start with an emergency medicine," he said.

The ISB professor said conventional measures such as interest-rate increases, measured reserve intervention, and incentives for stable, long-term foreign investment should have been tried first. The aim, he said, should have been to prevent disorderly movements rather than control the rupee's direction or defend a predetermined level.

Tantri pointed to Indonesia as an example of a country that recently used such conventional measures. "India instead began with an emergency measure," he said.

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'Emergency Measure Has Created Five Major Risks'

The first risk, according to Tantri, is the possibility of clustered dollar outflows. Much of the $136 billion is borrowed money that has to leave within a known period. While the direct cost of the RBI’s exchange-rate guarantee may remain manageable even if the rupee depreciates another 10%, markets could anticipate the large repayments and start exiting before maturity.

A bad geopolitical situation three years from now, he said, could turn those scheduled outflows into serious pressure on the rupee.

The second risk is that FCNR(B) inflows could partly displace ordinary remittances. Some NRIs who would otherwise have sent money to India may instead have placed it in exchange-rate-protected deposits. If that happens, Tantri said, India would have replaced stable, non-debt foreign-exchange inflows with borrowed dollars that have to be repaid.

The third risk is that defending visible exchange-rate levels could invite markets to test them. Once a central bank signals the levels it is determined to defend, markets acquire a target, the professor said. If those levels eventually break despite intervention, the adjustment could be abrupt.

The fourth risk is that temporary rupee appreciation could make it easier for foreign investors to exit. With equities already under pressure, Tantri said India was effectively subsidising their exit.

"If NRIs and foreign investors deserve such support, perhaps there is nothing wrong with paying ₹3,000 a month to poor women. I never thought I would say that," he said.

The fifth risk is the creation of an enormous reserve of money. The foreign-currency inflows have added to the reserve money, which can multiply through the banking system into deposits and credit. Unless it is durably sterilised, Tantri warned, this could create serious inflationary pressure one or two years from now.

He said seven-day reverse-repo auctions would only postpone the problem.

What RBI Can Do

The finance professor said the RBI should begin "damage control" rather than wait for the risks to materialise. It could absorb excess liquidity more durably through a higher cash reserve ratio, Market Stabilisation Scheme bonds or similar instruments, he said.

He also suggested encouraging FCNR(B) depositors to withdraw early and invest the proceeds in Indian equities, businesses, or housing, with limited tax and procedural relief.

The RBI could also consider raising interest rates to contain future inflation and support the rupee, Tantri said.

The government, meanwhile, should seek stable foreign-exchange inflows through measures such as a substantial reduction in capital-gains tax. The resulting revenue loss could be offset by cutting wasteful capital expenditure, including airports built where there is insufficient demand, he said.

Tantri also suggested that increasing Chinese imports was another option, though he did not recommend it for strategic reasons. He said India could instead benefit from a reversal in global conditions, such as an AI boom that goes bust and sends capital back to India, a collapse in crude prices, or another positive supply shock. "I desperately hope that something like this happens," he said.

The professor ended with a warning: "Finally, we should pray to Krishna, or whichever god one believes in, that no major geopolitical or financial disturbance occurs when these deposits mature."