FCNR Liquidity Boost May Prove Transitory

Reserve Bank of India data show that Foreign Currency Non-Resident, or FCNR(B), deposits have so far collected $36.73 billion. Market expectations are that the total could reach $60 billion-$70 billion by the end of September.

These numbers suggest a substantial addition to domestic liquidity. But assessing the impact requires a closer look at the factors that will both add to and drain liquidity over the remainder of 2026-27.

Core liquidity is currently around ₹6.75 trillion. This comprises approximately ₹3.45 trillion of banking system liquidity and ₹3.30 trillion of government cash balances with the RBI.

By the end of September, fresh FCNR(B) accretion could amount to another $27 billion-$30 billion. At the prevailing exchange rate, this would add approximately ₹2.85 trillion to core liquidity, potentially taking it to around ₹9.60 trillion.

That, however, is unlikely to be the liquidity position that prevails at the end of the financial year.

Currency in circulation stood at ₹41.68 trillion at the end of 2025-26. It had already increased to ₹42.76 trillion by July 31, an expansion of ₹1.08 trillion in the first four months of 2026-27.

 

Assuming currency in circulation grows by 9-10% during the full year, the total liquidity leakage could be around ₹4.17 trillion. Since ₹1.08 trillion has already occurred, another ₹3.10 trillion could leave the banking system by March 2027. This would reduce the projected core liquidity of ₹9.60 trillion at the end of September to around ₹6.50 trillion by March.

March Unwind

Two more liquidity drains must be considered. The first is the increase in banks’ cash reserve ratio balances. The second is the maturity of government securities held by the RBI during the remainder of 2026-27, together with coupon payments made to the central bank.

These two components could together absorb around ₹1.25 trillion, reducing core liquidity to approximately ₹5.25 trillion.

Then comes the RBI’s outstanding forward position.

According to the latest data, the RBI had a short forward position of $24 billion in contracts maturing in more than three months but within one year as of June 30. The maturity of these contracts requires the RBI to deliver dollars and receive rupees, thereby withdrawing rupee liquidity.

If around $20 billion of these contracts matures by March 2027, the resulting liquidity withdrawal could be approximately ₹1.90 trillion. Core liquidity could consequently fall to around ₹3.35 trillion by the end of March.

Of this, banking system liquidity could be around ₹2 trillion and government cash balances around ₹1.35 trillion. That would be a perfectly acceptable level of system liquidity under a neutral liquidity stance.

These calculations assume that India’s balance of payments does not improve materially, other than through the projected FCNR(B) inflows.

Policy response
The more important question is how the RBI’s liquidity reaction function will evolve. The central bank could face a substantial build-up of liquidity in the near term, even though much of it may unwind over the following six months.

That argues for using temporary instruments such as variable rate reverse repo auctions of varying maturities, rather than durable liquidity-withdrawal measures such as open market sales or an incremental cash reserve ratio.

An incremental CRR would also sit uneasily with the original policy logic. If incremental FCNR(B) deposits have been exempted from CRR and statutory liquidity ratio requirements to encourage inflows, imposing an incremental CRR elsewhere to absorb the resulting liquidity would partly defeat the purpose of that exemption.

System liquidity is also likely to fluctuate sharply during September because of advance tax payments, goods and services tax collections and excise duty outflows. October and November typically see higher currency leakage because of the festive season. With Uttar Pradesh elections due by May 2027, currency demand could pick up again during February and March.

For these reasons, VRRR auctions of different maturities make more sense than a permanent withdrawal of liquidity.

The RBI’s recent VRRR announcements, and the active participation in these auctions, already point in this direction. It is also in the interest of market participants to use the VRRR window to place temporary surplus funds, rather than allow excess liquidity to encourage weaker credit underwriting or investment at suboptimal yields.

OIS implications
Should this liquidity path materialise, the six- to 12-month overnight indexed swap curve is likely to find support around current levels.

The one-year OIS is currently pricing slightly more than two 25-basis-point rate increases over the next year. A cumulative increase of around 60 basis points appears to be a reasonable base case, with hikes potentially coming in December 2026 and April 2027, or in February and April 2027.

The one-year ahead 1year OIS  is currently trading at around 6.25%. Receiving at these levels could be attractive if the RBI delivers only two rate increases and manages the temporary liquidity surplus mainly through VRRR auctions. This view assumes a terminal repo rate of 5.75%.

Transmission gap
The larger point is that even the present core liquidity surplus of ₹6.75 trillion has not been sufficient to bring down money-market borrowing costs.

Three-month certificates of deposit are trading at around 6.60%, compared with approximately 5.28% for three-month Treasury bills. One-year CDs are trading at around 7.10%, against about 5.70% for one-year Treasury bills.

As a result, yields on one- to three-year AAA-rated public-sector undertaking bonds remain elevated at around 7.30-7.40%.

The current level of core liquidity is therefore not, by itself, sufficient to bring down money-market yields. This also strengthens the case against prematurely imposing durable liquidity-withdrawal measures in response to the expected FCNR(B) inflows.

The large addition to domestic liquidity from FCNR(B) deposits may prove transitory. The RBI should therefore manage the near-term increase through temporary instruments, while recognising the substantial liquidity drains that could emerge by March 2027.

The task is to prevent the temporary surplus from disrupting short-term markets without withdrawing liquidity so durably that bond yields become dislocated again, as they did between February and May 2026.