Foreign currency non-resident (FCNR) deposits have emerged as an important source of support for India’s external finances, helping strengthen foreign exchange reserves and providing some stability to the rupee despite weak foreign institutional investor (FII) flows. However, the cushion provided by these inflows may not be enough to address longer-term external pressures, according to Nuvama Research.
In its latest economy report, Nuvama estimated that FCNR inflows have contributed to an increase of around $100 billion in India’s foreign exchange reserves. The additional reserves have helped support both the domestic currency and the balance of payments (BoP) at a time when overseas portfolio investors have remained cautious.
The brokerage said the recent improvement in external stability should therefore be viewed in the context of the strong FCNR inflows rather than as a complete turnaround in India’s capital flows.
“FCNR inflows have stabilised INR and BoP for now, but sustained external stability will eventually require a meaningful return of FII flows,” Nuvama said.
FCNR Deposits Strengthen External Buffer
FCNR deposits have played a key role in supporting India’s capital account while FII activity has remained subdued. According to the report, the increase in these deposits coincided with greater stability in the rupee, offering relief to India’s external position.
Nuvama described the development as a temporary cushion for the balance of payments. The inflows have helped add to the country’s reserve stock and provided greater room to manage external pressures.
However, the report cautioned that this support cannot necessarily be treated as a permanent replacement for portfolio capital. Once the impact of FCNR inflows is absorbed, the sustainability of India’s external position could depend more heavily on the return of foreign investors.
Liquidity Gets A Boost
The impact of FCNR inflows has not been limited to foreign exchange reserves and the rupee. Nuvama also pointed to an improvement in domestic banking-system liquidity.
Systemic liquidity increased from roughly 1 per cent to 3 per cent of net demand and time liabilities (NDTL) in September following the inflows. Greater liquidity can potentially create more room for banks to lend and support financial conditions.
However, Nuvama expects the effect on credit growth to be relatively constrained. Bank credit growth has already been running at approximately 19 per cent for the past two months, while an unfavourable base effect is expected to emerge from October.
Goods Trade Deficit Raises Concern
The report also drew attention to another pressure point in India’s external accounts: the widening merchandise trade deficit.
While services exports and remittances from non-resident Indians (NRIs) continue to provide substantial support to the current account, Nuvama said these inflows are increasingly offsetting a deterioration in the goods trade balance.
India’s merchandise trade deficit has climbed to around 9 per cent of GDP, which the report described as a decade-high. This comes at a time when nominal GDP growth is also close to its lowest level in about a decade.
The combination creates a challenge for India’s external position. Strong services exports and remittances can help narrow the overall current-account gap, but a persistently large goods deficit increases the importance of stable capital inflows.
FII Return Key For Sustained Stability
Against this backdrop, Nuvama believes a meaningful revival in FII flows will eventually become important for maintaining external stability. FCNR deposits have provided substantial support during a period of weak portfolio flows, but that support could diminish as the inflows are absorbed.
A sustained return of foreign institutional investment would provide another source of capital to help finance India’s external requirements. Until then, the rupee and balance of payments are likely to remain supported by the combination of foreign exchange reserves, FCNR inflows, services exports and NRI remittances.
