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Subject: “BoP,FDI,FPI,External Financing”

  • FCNR(B) deposits: Understanding who finally bears the foreign exchange risk

    Why in the News

    The Reserve Bank of India (RBI) opened a special swap facility in June to draw money from non resident Indians into FCNR(B) deposits. The full name is Foreign Currency Non Resident (Bank), and such a deposit is held and repaid in foreign currency rather than in rupees. The step answered pressure on the rupee from high oil prices and an aim of building up foreign exchange reserves. The facility protects banks against exchange rate loss on the principal. It does not cover the interest, which is owed in dollars and has to be arranged by the banks themselves. That split is what decides who finally carries the currency risk.

    What is an FCNR(B) deposit and what did the special swap facility offer?

    1. A deposit denominated in foreign currency: A non resident places dollars or another permitted currency with an Indian bank, and the bank repays in that same currency, so the depositor carries no rupee risk.
    2. The term of the money: These deposits typically run for three to five years, which is when the principal and the accumulated interest fall due.
    3. What the swap added: The bank passes the foreign currency to the central bank for rupees and receives a commitment to reverse the exchange at an agreed rate on maturity.
    4. The window is shut: Fresh deposits under the facility stopped on 31 August 2026.

    Why was the window opened, and what did it actually raise?

    1. The response overshot the target: Banks mobilised more than $127 billion through these deposits against an initial target of about $50 billion.
    2. Funding turned cheap: The scheme gave banks foreign currency at a lower cost than borrowing abroad on their own credit would have carried.
    3. Reserves rose with it: The foreign currency handed to the central bank added substantially to India’s reserve stock.

    What does protecting the principal cost the central bank?

    1. The hedging bill sits with the central bank: It bears the cost of covering the currency exposure on the principal, put at up to 3% a year by BofA Securities Research and taken at about 3% a year by SBI Research.
    2. The annual and cumulative numbers: On an assumed mobilisation of $65 billion to $70 billion at that rate, SBI Research calculated a notional cost of about $2.1 billion a year and about $10.5 billion over five years.
    3. Measured against the reserve stock: Against reserves of around $700 billion, the five year cost works out to 1.45% of the stock.

    What offsets that cost?

    1. The reserves themselves earn a return: BofA Securities Research estimated a yield of around 4.5% to 5% on the reserves generated, enough to more than cover the hedging cost across a five year holding.
    2. Placement is chosen for yield: Part of the money may be invested in United States government securities because those yields are higher.
    3. Part of the outgo is already recovered: SBI Research said the central bank had rebuilt $31.2 billion of its foreign currency assets by 7 August 2026, equal to 55% of the amount mobilised to that point.

    Why have most banks left the interest leg unhedged?

    1. The swap stops at the principal: Banks have to source the dollars for interest payments and manage that exposure on their own books.
    2. The split runs by ownership type: Foreign banks are largely hedging this exposure. Most state run banks and several private sector Indian lenders have left it open.
    3. Cost is the stated reason: Bankers cite the price of cover on a three to five year exposure, which is of the same order as the cost the central bank carries on the principal.
    4. The payment timing invites the gamble: Interest on these deposits is paid only at maturity, so some banks plan to buy dollars in the spot market when the payment actually falls due.

    What happens to an unhedged bank if the rupee weakens?

    1. The arithmetic of one payment: Interest of $1 million costs Rs 9.5 crore at Rs 95 to the dollar, and Rs 10 crore if the dollar reaches Rs 100 at maturity.
    2. Cover decides who absorbs it: A hedged bank is protected against that movement, and a lender that left the exposure open bears the higher rupee cost.
    3. The risk is correlated across lenders: A sharp fall in the rupee would push many banks to buy dollars at the same time, adding to dollar demand and to pressure on the currency.
    4. The exposure has not gone away: The scheme moved currency risk between parties rather than removing it from the system.

    Challenges to the FCNR(B) swap route to reserve building

    1. Reserves built this way are borrowed reserves: Non resident deposits count within India’s external debt, so the reserve stock rises with a matching liability against it. Eg. Non resident deposits are among the largest components in the Finance Ministry’s quarterly external debt statement.
      The Fix: Publish the debt creating share of any reserve addition alongside the headline reserve figure.
    2. Maturities bunch at one point in time: A window opened over a single quarter falls due over a single quarter, which concentrates the outflow. Eg. The concessional swap window of 2013 raised about $34 billion and came up for redemption together in late 2016.
      The Fix: Stagger the maturities permitted under a window across quarters rather than letting the market settle on one tenor.
    3. The open exposure sits with the thinnest buffers: Public sector lenders hold less capital against a valuation loss than the foreign banks that are covering the same risk. Eg. Several public sector banks required recapitalisation from the Union Budget through the second half of the 2010s.
      The Fix: Set a supervisory ceiling on the share of foreign currency interest liability a bank may leave uncovered.
    4. The facility substitutes for adjustment: Attracting deposits to steady the currency postpones the correction that a persistent current account gap eventually forces. Eg. The rupee continued to depreciate through the years after the 2013 defence of the currency ended.
      The Fix: Tie any such window to a stated reserve adequacy target, so it closes as a one time step instead of becoming a standing instrument.

    Conclusion

    The swap changed the address of the currency risk without retiring it. The central bank now holds an exposure that depositors were unwilling to take, and lenders hold the portion the central bank declined. Whether that is prudent rests on a rupee path nobody can commit to. The supervisory question to watch is whether banks will be required to cover the foreign currency leg they have chosen to leave open.

    Back2Basics: Non resident deposit accounts

    1. NRE account: A Non Resident External account is held in rupees, and both principal and interest are freely repatriable.
    2. NRO account: A Non Resident Ordinary account is held in rupees for income earned in India, and repatriation out of it is capped.
    3. Where the currency risk sits: In a rupee denominated non resident account the depositor bears the exchange risk, which is the reverse of a foreign currency denominated account.

    Matching Previous Year Question

    “[2019] Consider the following statements: 1. Most of India’s external debt is owed by governmental entities. 2. All of India’s external debt is denominated in US dollars. Which of the statements given above is / are correct? (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2 ANSWER: (d)”

  • A BIT of a reset, with a wider debate

    Why in the News

    India is revising its model bilateral investment treaty (BIT), and the revised text will soon be placed before the Union Cabinet. The Finance Minister signalled the intention to revamp the 2015 Model BIT in the Union Budget speech of 2025. The 2015 model was itself the product of an appraisal launched after several foreign investors sued India for treaty breaches. That appraisal produced two outcomes: unilateral termination of existing treaties, and a new model text as the basis for fresh negotiations. Debate on the current revision has concentrated almost entirely on what the treaty should say. The process by which the text is written has attracted almost no attention, and that is where the democratic deficit sits.

    What is the 2015 Model Bilateral Investment Treaty?

    1. What a model treaty is: A model bilateral investment treaty is the template text a country negotiates from when it concludes investment protection agreements with other countries.
    2. What such a treaty does: It grants legal protections to investors of one country investing in the other. It also gives those investors a route to bring a claim directly against the host state before an international arbitral tribunal.
    3. The two objectives it must balance: Investment treaties sit between investment protection at one end of the spectrum and the state’s right to regulate at the other.
    4. When India adopted it: India circulated a draft in 2015 and adopted the revised version in December 2015.

    Why has the 2015 model produced so few treaties?

    1. The record: India has concluded only a handful of treaties on the basis of the 2015 model in the last decade or so.
    2. The imbalance in the text: The model tilts heavily towards the state’s right to regulate and away from the protection of the investment.
    3. What capital exporting countries read into it: Countries that export capital to India doubt the legal protection available to their investments under such a text.
    4. What compounds the doubt: High regulatory risk, governance models that are not well developed, and a slow judicial system add to that concern.

    What legal changes are being proposed, and what is being left out?

    1. Easier access to arbitration: Experts have argued for making it easier for a foreign investor to take a treaty claim to international arbitration.
    2. Stronger substantive protections: The protections given to foreign investment in the text would be enhanced.
    3. Investment facilitation: The revised model would carry more measures aimed at facilitating investment rather than only protecting it.
    4. The half of the review that is missing: A treaty review has two components, the substantive and procedural changes to the law, and the process followed to make the outcome robust. Only the first has been deliberated.

    What is the democratic deficit in treaty making?

    1. The all-affected principle: International economic treaties have a conspicuous impact on citizens, which raises the question whether those affected should have a right to participate in the decision.
    2. What the term means: Democratic deficit refers to insufficient oversight of the technocrats, bureaucracies and political executive who negotiate treaty frameworks behind closed doors.
    3. Where it originated: The term originated in European debates on the accountability of decision making removed from elected legislatures.
    4. The first form the gap takes: Parliamentary supervision of the treaty making process is absent or inadequate.
    5. The second form: There is no external consultative process with other stakeholders, including subject matter experts and civil society organisations.

    What do other countries do before adopting an investment treaty text?

    1. United Kingdom and Australia: Both mandatorily place the text of a negotiated treaty on the floor of Parliament before ratification, so the legislature can express its views on it.
    2. Norway: Two rounds of public consultation were held on an updated draft model BIT, in 2008 and in 2015.
    3. Colombia: The country released its model BIT for public consultation.
    4. What the set demonstrates collectively: Consultation is applied to the model text itself and not only to a concluded treaty, which means the template a country negotiates from is treated as a public policy document rather than an internal instruction.

    What did India’s own 2015 consultation produce?

    1. The public comment stage: India circulated its draft 2015 model BIT for public comment in March 2015.
    2. The expert study it enabled: That opening allowed the Law Commission of India to assemble a team of experts to study the draft text.
    3. The report: The Law Commission’s 260th report made recommendations on how to improve the draft model treaty.
    4. What was carried through: Not all of the recommended changes were reflected in the version India finally adopted.

    What consultative process is proposed for the revision?

    1. What has presumably already happened: Intra-governmental deliberation on the model text has been undertaken inside government.
    2. A core team of external experts: Form a team outside government of international lawyers and economists drawn from universities, research institutions and think tanks, to act as a sounding board.
    3. Wider stakeholder engagement: Invite industry bodies, arbitrators, law firms and other civil society organisations to offer their views on the model text.
    4. A public draft: Prepare a draft and place it in the public domain, inviting comments from the public at large.
    5. Parliamentary scrutiny: Place the draft model treaty on the floor of Parliament for discussion, and rope in the relevant department related parliamentary committees.
    6. The standard the exercise must meet: The process must engage with dissenting views rather than run as a box ticking formality.

    Challenges to revising the Model Bilateral Investment Treaty

    1. A model text does not bind the counterparty: A model is a negotiating template, so a partner with stronger bargaining power will press its own text and the model’s provisions will be traded away one by one. Eg. Investment provisions have been among the unresolved items in India’s long running negotiations with the European Union.
      The Fix: Publish the provisions treated as non-negotiable separately from those open to trade-off, so a concluded treaty can be judged against a stated position rather than against the template.
    2. The local remedies requirement is long relative to the delay it addresses: The 2015 model requires an investor to pursue domestic remedies for five years before starting international arbitration, in a system whose delay is itself the investor’s complaint. Eg. White Industries Australia v Republic of India (2011), the first adverse award against India, arose from delay in Indian courts enforcing a commercial arbitration award.
      The Fix: Tie the domestic remedies condition to a defined procedural stage being reached rather than to a fixed number of years.
    3. Termination does not end exposure: A terminated treaty carries a survival clause that keeps protections alive for investments made before termination, so liability continues for years after the instrument goes. Eg. The 2020 Vodafone award was rendered under the India-Netherlands treaty after India had begun issuing termination notices in 2016.
      The Fix: Negotiate replacement treaties with express provisions displacing the survival clauses of the instruments they replace.
    4. Taxation is carved out of the model’s scope: The 2015 model excludes taxation measures from treaty protection, which removes the very category of dispute that produced India’s largest awards. Eg. The 2020 Cairn Energy award, made under the India-United Kingdom treaty, concerned a retrospective tax demand.
      The Fix: Bring expropriatory tax measures within the treaty’s scope while keeping bona fide tax policy outside it.
    5. Consultation without a legal basis is discretionary: No Indian law requires the executive to lay a treaty text before Parliament, so every consultation depends on the willingness of the government of the day. Eg. Treaties are concluded under executive power and reach Parliament only where implementing them requires a change in domestic law.
      The Fix: Enact a treaty scrutiny statute setting out which categories of treaty must be laid before Parliament and for how long before ratification.

    Conclusion

    The revision is being handled as a drafting exercise. The gap it does not close is that India has no settled procedure for producing a treaty text at all, so the quality of the next model rests on the discretion of whoever drafts it. A text written without external scrutiny will attract the same legitimacy objection whichever direction it moves the balance in. What to watch is whether the draft reaches the public domain and the floor of Parliament before the Union Cabinet clears it, or only after.

    Bilateral Investment Treaties in India

    1. What they are: A bilateral investment treaty is an agreement between two countries setting the terms on which each protects investors from the other in its own territory.
    2. How disputes under them are settled: Most such treaties allow an investor to bring a claim directly against the host state before an international arbitral tribunal, without routing it through its own government.
    3. India’s treaty stock: India signed its first such treaty with the United Kingdom in 1994 and went on to sign more than 80. From 2016 it began terminating them and moved to renegotiate on the 2015 model.
    4. What has been concluded since: Treaties concluded on the newer template include those signed with the United Arab Emirates and with Uzbekistan in 2024.

    Constitutional Framework Governing Treaty Making

    1. Article 246 with Entry 14 of the Union List: Places entering into treaties and agreements with foreign countries, and implementing them, within Parliament’s exclusive legislative field.
    2. Entry 13 of the Union List: Covers participation in international conferences and associations, and the implementing of decisions taken at them.
    3. Article 253: Empowers Parliament to make law for the whole or any part of India to implement any treaty, agreement or convention with another country.
    4. Article 73: Extends the Union executive’s power to every matter on which Parliament may legislate, which is the basis on which the executive concludes a treaty without prior legislative approval.

    Back2Basics: Law Commission of India

    1. What it is: A non-statutory executive body constituted by the Government of India to advise on law reform.
    2. How it is constituted: It is set up for a fixed term by an order of the Ministry of Law and Justice, and is chaired by a retired judge.
    3. What it does: It examines existing laws and specific references made by the government, and submits reports carrying recommendations.
    4. The weight its reports carry: Its recommendations are not binding, and a change in law follows only where the government accepts them.

    [2010] A great deal of Foreign Direct Investment (FDI) to India comes from Mauritius than from many major and mature economies like UK and France. Why?

    (a) India has preference, for certain countries as regards receiving FDI

    (b) India has double taxation avoidance agreement with Mauritius

    (c) Most citizens of Mauritius have ethnic identity with India and so they feel secure to invest in India

    (d) Impending dangers of global climate change prompt Mauritius to make huge investments in India

  • Norms allowing e-comm cos to keep inventory notified by govt

    Why in the News

    The Department of Economic Affairs, in the Ministry of Finance, has amended the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 to let e-commerce entities hold inventory. The permission is confined to goods meant for export. Those goods must be manufactured or produced in India. Foreign Direct Investment (FDI) in inventory based e-commerce retailing remains barred, so a foreign funded platform still cannot own the stock it sells to Indian consumers. The change separates a platform’s right to own goods from its right to sell them in India.

    What is inventory based e-commerce, and how does it differ from the marketplace model?

    1. Inventory based model: The platform owns the goods it lists and sells them directly to the buyer.
    2. Marketplace model: The platform runs a digital facility connecting independent sellers to buyers. It does not own the stock it displays.
    3. The investment line between them: Foreign investment up to 100 percent under the automatic route is permitted in the marketplace model. Foreign investment in the inventory based model is not permitted.

    What has the amendment changed?

    1. A permission tied to export: An e-commerce entity may now maintain inventory where the goods are meant for export.
    2. A domestic origin condition: The goods so held must be manufactured or produced in India.
    3. The retail bar is untouched: Foreign investment in inventory based e-commerce retailing has not been permitted.
    4. The route taken: The Department of Economic Affairs inserted the provision into the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, which is the instrument that carries India’s foreign investment conditions in law.

    Why does an export only carve out change what a foreign funded platform can do?

    1. Ownership of stock becomes lawful for one purpose: A foreign funded platform may buy, own and warehouse Indian made goods, provided the buyer sits outside India.
    2. The domestic retail rationale survives: The bar exists to stop a platform holding foreign capital from selling its own stock to Indian consumers at prices small retailers cannot match. An export sale does not enter that market.
    3. Exports gain an aggregator: A small manufacturer without overseas logistics can sell to a platform that takes title to the consignment and ships it out.
    4. The test shifts from ownership to destination: Compliance now turns on where a consignment ends up, which is a harder thing to observe than who owns it.

    Challenges to the export only inventory permission

    1. Diversion into the domestic market: Stock held under the export permission can be sold at home unless each consignment is matched to a foreign buyer. Eg. Duty free inputs meant for export production have repeatedly been the subject of Directorate of Revenue Intelligence cases over domestic diversion.
      The Fix: Require the platform to reconcile inventory held under this permission against shipping bills filed with Customs, and treat an unreconciled balance as a contravention.
    2. No stated threshold for what counts as made in India: The condition turns on goods manufactured or produced in India, and a low value assembly operation meets that description. Eg. Domestic value addition has been a running dispute under the Production Linked Incentive scheme for electronics, where imported kits are assembled locally.
      The Fix: Attach a stated domestic value addition threshold to the permission, as the Production Linked Incentive schemes already do.
    3. Enforcement acts long after the sale: Contraventions under the Foreign Exchange Management Act, 1999 are penalised or compounded after the fact, so a breach is corrected once the goods have already moved. Eg. Proceedings against large foreign funded e-commerce platforms over foreign investment conditions have run for years without a settled outcome.
      The Fix: Require an annual statutory auditor’s certificate on compliance with the export condition, filed with the Reserve Bank of India.
    4. The marketplace disputes are left where they were: The standing complaints of small retailers concern preferential seller arrangements inside the marketplace model, which this permission does not touch. Eg. The Competition Commission of India’s investigation into preferred sellers and deep discounting on major platforms began in 2020.
      The Fix: Conclude the pending competition proceedings on preferential seller arrangements, so the marketplace conditions are enforced on their own terms.

    Conclusion

    India’s foreign investment rules now treat ownership of goods and sale of goods as two separate permissions. The carve out is drawn narrowly, so its practical worth depends entirely on how the export destination is verified rather than on the width of the wording. The marker to watch is whether operating conditions specifying that verification follow, and whether foreign funded platforms build export volumes large enough to make the permission material.

    Back2Basics: Foreign Exchange Management (Non-debt Instruments) Rules, 2019

    1. What they are: Rules made under the Foreign Exchange Management Act, 1999 governing investment by a person resident outside India in equity and other non-debt instruments.
    2. Who issues them: The Department of Economic Affairs in the Ministry of Finance notifies them.
    3. What they carry: Sectoral caps, entry routes and the specific conditions attached to foreign investment in each sector.
    4. Why they matter: A change announced as foreign investment policy takes legal effect only when these Rules are amended.

    Matching Previous Year Question

    “[2020] With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic? (a) It is the investment through capital instruments essentially in a listed company. (b) It is a largely non-debt creating capital flow. (c) It is the investment which involves debt-servicing. (d) It is the investment made by foreign institutional investors in the Government securities. ANSWER: (b)”

  • Needed: More stable foreign capital

    Why in the News

    Inflows through the Reserve Bank of India’s (RBI) forex swap facility reached $136.3 billion by 31 August. The facility was part of a set of measures announced in June to draw capital into the country, and it was opened against doubts about how much could be raised in tight global financial conditions. Foreign exchange reserves have touched a record $729 billion and the rupee’s slide has been arrested. The same inflow has pushed the banking system’s liquidity surplus to Rs 6.7 lakh crore, at a point when inflation is edging up and the Monetary Policy Committee (MPC) may need to raise rates. Most of the money arrived as Foreign Currency Non Resident Bank, or FCNR(B), deposits, which are repayable debt rather than the stable equity investment a current account deficit requires.

    What is the FCNR(B) and swap route?

    1. The deposit is a foreign currency liability of the bank: An FCNR(B) deposit is a term deposit placed by a non resident Indian in foreign currency with an Indian bank. The bank repays principal and interest in that same currency, so the depositor carries no rupee exchange risk.
    2. The swap converts those dollars into rupees at a fixed cost: Under a swap facility the bank sells the mobilised dollars to the RBI for rupees, with an agreement to reverse the transaction at a pre agreed rate on a fixed future date.
    3. A concessional swap rate is what makes the route attractive: The central bank absorbs part of the hedging cost, which lifts the effective return the bank can offer a depositor without taking currency risk itself.
    4. Two borrowing channels run alongside: External Commercial Borrowings (ECB), meaning foreign currency loans raised abroad by Indian companies, and Overseas Foreign Currency Borrowings (OFCB) raised by banks, carry the balance of the flows.

    How large were the inflows, and what did they buy?

    1. The response exceeded expectations: $136.3 billion came in by 31 August, of which $63.5 billion arrived in the last ten days alone.
    2. The deposit route dominated: $127 billion came through FCNR(B), with the balance through the ECB and OFCB channels.
    3. Reserves hit a record: Foreign exchange reserves reached $729 billion on 21 August, which strengthens the buffer for external stability.
    4. The currency stabilised: The rupee’s fall was stemmed and it touched a two month high of Rs 94.60 to the dollar on 3 September.
    5. The window is not exhausted: About $9 billion more remains available through an ECB and OFCB swap window that stays open till December.

    Why does the same inflow complicate monetary management?

    1. Every dollar swapped injects rupees: The liquidity surplus in the banking system rose from over Rs 3 lakh crore at the beginning of August to Rs 6.7 lakh crore by the end of it.
    2. Independent estimates put the overhang higher: Surplus liquidity stood at Rs 9.71 lakh crore on 2 September, against a preferred level of about Rs 2.7 lakh crore.
    3. One absorption tool is doing all the work: The central bank has responded with variable rate reverse repo auctions, in which banks bid to park surplus funds with it for a fixed term. More tools will be needed at this scale.
    4. The timing runs against the policy stance: Inflation is edging upwards and the MPC may need to tighten, and a large surplus pushes short term rates below the policy rate in the opposite direction.
    5. Growth gives the committee room: Robust first quarter growth provides the space and comfort to tighten if the inflation trajectory demands it.

    Why is debt type inflow not a substitute for stable capital?

    1. The underlying deficit is unaddressed: India runs a current account deficit, which has to be financed every year regardless of what a one time window raises.
    2. Equity flows remain thin against the need: Foreign portfolio investors have been net equity buyers over recent months and net foreign direct investment is inching upwards, neither at a scale that finances the deficit on its own.
    3. Deposits are dated money: FCNR(B) deposits are repayable on maturity, so a large single vintage creates a redemption cliff for the central bank to plan around.
    4. The external environment governs the next round: Tighter global financial conditions will influence flows, so a window that worked this year cannot be assumed to work again.

    Challenges to the FCNR(B) and swap route

    1. Redemption bunches at a single future date: A large tranche raised in one window matures together, so the central bank has to arrange dollars for repayment in one narrow period. Eg. The $26 billion raised through the 2013 FCNR(B) swap window came up for redemption together in 2016 and had to be managed through forward market operations.
      The Fix: Stagger maturities across tenors at the point of mobilisation rather than offering a single uniform term.
    2. The subsidy sits on the central bank’s books: A concessional swap rate transfers hedging cost from the banking system to the central bank, which bears the loss if the currency moves against it. Eg. The 2013 window was priced at a concessional swap rate well below the prevailing market forward premium.
      The Fix: Publish the fiscal and balance sheet cost of the concession alongside the inflow figure, so the instrument is judged on net terms.
    3. It raises the debt share of external financing: Deposits and borrowings add to external debt, and equity investment does not. The composition of external financing worsens as the headline reserve number improves. Eg. Short term external debt on residual maturity has repeatedly been flagged in the RBI’s own external debt statistics as a vulnerability indicator.
      The Fix: Tie the window to a parallel timetable for the sectoral foreign direct investment reforms that have been pending, so the debt raised buys time for an equity fix.
    4. Sterilisation of the rupee injection is costly: Absorbing the liquidity created requires paying interest to banks on funds parked with the central bank, which erodes its income. Eg. The surplus is currently being drained through variable rate reverse repo auctions at rates close to the policy rate.
      The Fix: Use longer tenor absorption instruments, including open market sales of government securities, so the drain matches the maturity of the inflow.
    5. The instrument is used as a currency defence rather than a funding decision: A window opened when the rupee is under pressure attracts money for the concession rather than for the economy’s return profile. Eg. Both the 2013 and the current windows followed a sharp depreciation episode.
      The Fix: Keep a standing, non concessional deposit and borrowing framework open through the cycle, so mobilisation does not depend on a crisis trigger.

    Conclusion

    The window has bought external stability and has handed the central bank a domestic liquidity problem in exchange. Neither outcome changes the structural position: a deficit country that finances itself with borrowed money stays exposed to the next tightening in global conditions. What to watch is the composition of financing over the coming quarters rather than the reserve headline, and specifically whether net foreign direct investment rises fast enough to reduce dependence on windows of this kind before the deposits fall due.

    Matching Previous Year Question

    “[2020] If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India? (1) Not depending on short-term foreign borrowings (2) Opening up to more foreign banks (3) Maintaining full capital account convertibility Select the correct answer using the code given below: (a) 1 only (b) 1 and 2 only (c) 3 only (d) 1, 2 and 3 ANSWER: (a)”

  • Gross FDI hit 15-year high of $30.7 billion in April-June 2026

    Gross FDI hit 15-year high of $30.7 billion in April-June 2026

    Why in the News

    Reserve Bank of India (RBI) data shows gross Foreign Direct Investment (FDI) inflows reached $30.7 billion in April-June 2026, the highest quarterly figure in fifteen years. Net FDI, which nets out repatriation and disinvestment by existing foreign investors, turned positive again in June 2026 at $1.3 billion, after a period of elevated repatriation had kept it depressed. Singapore, the Netherlands, the United States and Canada led the inflows, concentrated in manufacturing. The tension is between the strength of the gross inflow figure and the much smaller net figure, since heavy repatriation by existing foreign investors has been offsetting fresh inflows for several preceding quarters.

    What does the data show?

    1. Fifteen-year high in gross inflows: Gross FDI of $30.7 billion in a single quarter is the highest recorded in fifteen years, reversing a period of relatively subdued inflows.
    2. Net FDI turns positive: Net FDI turned positive in June 2026 at $1.3 billion, after running negative or near zero in preceding months.
    3. Source and sector concentration: Singapore, the Netherlands, the United States and Canada were the leading source countries, with manufacturing the leading destination sector.

    Why does the gap between gross and net FDI matter?

    1. Repatriation pressure: A large gap between gross and net FDI signals that existing foreign investors have been exiting or repatriating profits at a pace close to new inflows. This is a different signal from headline inflow growth alone.
    2. Policy implication: A durable improvement in net FDI, not gross inflows alone, is the more reliable indicator of investor confidence in staying invested in India over the medium term.

    Gross FDI vs Net FDI

    • Gross FDI: Fresh foreign investment entering India.
    • Net FDI: Gross inflows after accounting for repatriation and disinvestment.
    • A large gap between gross and net FDI indicates that substantial investment is also flowing out through existing investors.
    • Therefore, high gross FDI does not necessarily mean high net FDI.

    “[2022] Which one of the following situations best reflects “Indirect Transfers” often talked about in media recently with reference to India ?
    (a) An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment
    (b) A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment
    (c) An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India
    (d) A foreign company transfers shares and such shares derive their substantial value from assets located in India

  • Did Press Note 3 relaxations help attract more FDI?

    Why in the News

    The government’s March 2026 relaxation of Press Note 3 (2020) now allows the automatic route for foreign investors from land-border-sharing countries where the resulting stake is below 10 percent. Press Note 3 (2020) had required prior government approval for any foreign direct investment from an entity based in, or beneficially owned by, a country sharing a land border with India, a restriction imposed after India’s border tensions with China. Since the relaxation, 29 Foreign Direct Investment (FDI) projects together worth ₹4,895.65 crore have been reported as raised through the automatic route. The scale of that inflow is now being tested against whether it represents genuine new investment or capital that was already structured to qualify.

    What is Press Note 3 and why was it imposed?

    1. Origin in 2020 border tensions: The Department for Promotion of Industry and Internal Trade issued Press Note 3 in April 2020 requiring government approval for FDI from any country sharing a land border with India, a category that in practice targets China.
    2. Stated rationale of opportunistic acquisition: The measure was framed as a safeguard against opportunistic takeovers of Indian companies whose valuations had fallen sharply during the COVID-19 pandemic.
    3. No de minimis threshold in the original rule: The 2020 version applied government-approval scrutiny regardless of the size of the resulting stake, so even a marginal shareholding increase by an investor linked to a bordering country required clearance.
    4. Applied to beneficial ownership, not just direct investment: The restriction reaches an investment structured through a third country if the ultimate beneficial owner is based in a bordering country, closing a routing loophole.

    What has the March 2026 relaxation changed?

    1. Automatic route restored below a 10 percent threshold: Investment from a bordering-country-linked entity resulting in a stake below 10 percent in the Indian company no longer requires prior government approval.
    2. Retains approval requirement above the threshold: Any investment crossing the 10 percent stake mark, or any greenfield or strategic-sector investment, continues to require case-by-case government clearance.
    3. 29 projects reported since relaxation: ₹4,895.65 crore in FDI has been reported as raised through the automatic route across 29 projects since the relaxation took effect.

    Did the relaxation actually attract more FDI?

    1. Reported inflow is modest against India’s total FDI base: ₹4,895.65 crore is a small fraction of India’s annual FDI inflow, so a Press Note 3 relaxation limited to sub-10 percent stakes has not shifted aggregate FDI in a way that will show clearly in headline balance-of-payments data.
    2. The 10 percent cap limits which capital responds: A relaxation confined below the threshold attracts portfolio-style minority stakes rather than the strategic or controlling investment that would signal deeper industrial commitment.
    3. Difficult to isolate the relaxation’s own effect: FDI flows respond to multiple factors simultaneously, including global interest rates and India’s own growth outlook, making it hard to attribute the 29 reported projects solely to the policy change.
    4. Sectoral destination of the reported inflow remains the open question: Whether the ₹4,895.65 crore has gone into manufacturing capacity or into financial and services stakes shapes how much the relaxation has actually served its stated industrial goal.

    Conclusion

    The Press Note 3 relaxation has produced a measurable but modest reported inflow, ₹4,895.65 crore across 29 projects, since March 2026. Whether this represents a genuine widening of investor participation from land-border-sharing countries or capital that was already positioned to enter below the new threshold will become clearer as more reporting cycles pass.

    Back2Basics: Press Note 3 (2020)

    1. Issued by the Department for Promotion of Industry and Internal Trade under the Foreign Direct Investment policy framework, not a standalone statute.
    2. Requires government approval for FDI from, or beneficial ownership traced to, any country sharing a land border with India: China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar, and Afghanistan.
    3. Applies to both fresh investment and a change in beneficial ownership of an existing investment resulting from a transfer.
    4. Enforced through the Reserve Bank of India’s foreign exchange reporting framework under the Foreign Exchange Management Act, 1999.

    Matching Previous Year Question

    “[2022] Which one of the following situations best reflects “Indirect Transfers” often talked about in media recently with reference to India ?
    (a) An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment
    (b) A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment
    (c) An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India
    (d) A foreign company transfers shares and such shares derive their substantial value from assets located in India
    ANSWER: (d)”

  • FDI policy rejig for border nations spur Rs 5k cr investment: DPIIT

    Why in the News

    A relaxation in India’s rules on investment from land bordering countries has drawn 29 foreign direct investment (FDI) proposals worth ₹4,895.65 crore up to 20 August 2026. The relaxation was notified in March 2026. It permits a foreign entity carrying non controlling beneficial ownership of up to 10 per cent from a land bordering country to invest through the automatic route. Press Note 3 of 2020 had required prior government approval for any such investment, however small that land border shareholding was. What is now tested is whether a shareholding threshold can separate incidental Chinese exposure inside a global fund from Chinese strategic control of an Indian asset.

    What is Press Note 3 of 2020?

    1. The restriction: Imposed in April 2020, it made government approval mandatory for investment from any country sharing a land border with India.
    2. Stated purpose: It was aimed at preventing opportunistic takeovers of Indian firms during the Covid-19 pandemic, and stayed in force amid heightened national security concerns after the Galwan clash later that year.
    3. Country neutral drafting: The framework named no country, and China is the largest source of investment among India’s land neighbours.
    4. Uneven bite: Entities of Bangladesh and Pakistan can invest only through the government route. Flows from Nepal, Myanmar, Bhutan and Afghanistan are very small as a share of India’s total foreign investment.

    What conditions does the relaxed route carry?

    1. Indian control retained: The majority shareholding and control of the investee entity must rest at all times with resident Indian citizens, or with resident Indian entities that are themselves owned and controlled by resident Indian citizens.
    2. Threshold is a ceiling, not a waiver: A land border holding above 10 per cent still routes the investment through government approval, so the automatic route covers only diluted exposure.
    3. Time bound clearance for named goods: A 60 day deadline was approved for clearing proposals from land bordering countries, including China, in capital goods, electronic capital goods, electronic components, polysilicon, and ingot wafer for solar cells.

    Where has the relaxed route drawn money from?

    1. Sectors: The proposals span information technology, artificial intelligence, information and communication, manufacturing, pharmaceuticals, data centres and transport services.
    2. Jurisdictions: They were reported by investors and entities based in Mauritius, the United States, the Republic of Korea, Japan, Singapore, Luxembourg and the Cayman Islands, among others.
    3. Stated gain: The government’s own assessment is that the reform gives investors greater certainty, cuts transaction time and strengthens ease of doing business in India.

    Where has the Centre gone further than the ownership threshold?

    1. A strategic sector joint venture: In July 2026 the Centre cleared a joint venture between Dixon Technologies (India) Limited and Vivo Mobile India Limited for manufacturing electronic devices and smartphones, one of the first major approvals to Chinese investment in a strategic sector.
    2. Entry into power tenders: The Finance Ministry in July allowed four Chinese power equipment manufacturers with factories in India to bid for government tenders on critical power projects.
    3. A procurement exemption: TBEA Energy, Nanjing Electric India, New Northeast Electric India and Taikai Electric (India) were exempted from the public procurement rule requiring entities from land bordering countries to register with the relevant Indian authority before bidding.
    4. What is at stake in that equipment: The four firms make transformers, wires, high voltage switchgear and gas insulated switchgear used in transmission lines. New Northeast Electric India lists at least 11 transmission line projects across India.

    Challenges to the revised land border investment framework

    1. Beneficial ownership is hard to trace through layers: A 10 per cent test presumes the ultimate holder is visible, which layered holding structures defeat. Eg. Several of the reported proposals came through Mauritius and the Cayman Islands. The ultimate holder is not on the local register in either jurisdiction. Fix. Require a declaration of the ultimate beneficial owner at every layer, verified against the significant beneficial ownership register maintained under the Companies Act, 2013.
    2. A shareholding cap does not bound influence: Control travels through contracts as much as through equity. Eg. A minority holder with board nomination rights or a sole technology licence can direct a joint venture without owning a majority. Fix. Test control by board composition and contractual veto rights, not by shareholding percentage alone.
    3. Screening capacity is spread thin: No single body owns the security review of an inbound proposal. Eg. Screening runs across the Department for Promotion of Industry and Internal Trade, the Ministry of Home Affairs and the administrative ministry, each with its own timeline. Fix. Constitute a standing inbound investment security review committee with a statutory disposal deadline.
    4. Technology dependence persists in the sectors being opened: Approval eases entry without changing who owns the process knowledge. Eg. India imports most of its polysilicon and ingot wafer requirement for solar cells. Fix. Tie approval in those goods to a phased technology transfer and a rising domestic sourcing commitment.
    5. The government route stays slow for everyone else: Only the notified goods got a deadline, so other proposals still face open ended review. Eg. Land border proposals outside the notified list have historically taken well over a year to clear. Fix. Extend the 60 day discipline to every proposal on the government route, with reasons recorded for any extension.

    Conclusion

    The relaxed framework has been operative since March 2026 and has produced 29 reported proposals in five months. Press Note 3 itself stays on the books for any land border holding above the threshold, so the restriction has been narrowed rather than withdrawn. The next milestone is disposal of proposals under the 60 day window for the notified goods, and whether the Dixon and Vivo clearance becomes a template for a wider, sector by sector opening.

    Foreign Direct Investment in India

    1. About: Foreign direct investment is cross border investment that establishes a lasting interest in an enterprise abroad, in the definition used by the Organisation for Economic Cooperation and Development.
    2. Routes: Most sectors permit 100 per cent foreign investment through the automatic route, and the remainder require prior government approval.
    3. Cumulative scale: India’s cumulative inflows crossed about $1.14 trillion between April 2000 and December 2025, with nearly 70 per cent of that arriving in the last decade.
    4. Recent flows: Gross inflows reached a three year high of $81 billion in 2024-25, led by services and manufacturing.

    Laws and Rules Governing Foreign Investment

    1. Foreign Exchange Management Act, 1999: The parent statute governing cross border transactions and capital account flows into and out of India.
    2. Foreign Exchange Management (Non-debt Instruments) Rules, 2019: Notified by the Finance Ministry, these fix sectoral caps, entry routes and pricing guidelines for equity investment.
    3. Consolidated FDI Policy Circular: A single compiled statement of sectoral policy, which Press Notes amend between editions.
    4. Competition Act, 2002: Acquisitions above notified thresholds need Competition Commission of India clearance.

    Challenges in Attracting Foreign Direct Investment

    1. Policy unpredictability: Rules that change mid cycle force investors to restructure entities already built. Eg. Repeated shifts in e-commerce foreign investment norms forced marketplace operators to redraw their seller structures. Fix. Publish a standstill period between the notification of a sectoral rule change and its taking effect.
    2. Land acquisition: Site control is the binding constraint on greenfield manufacturing. Eg. POSCO abandoned its Odisha steel project after a decade of unresolved land disputes. Fix. Build titled, pre cleared land banks held by state industrial corporations and offered on long lease.
    3. Geographic concentration: Inflows cluster in services and a few urban states. Eg. A handful of states absorb the bulk of equity inflows reported each year. Fix. Offer differential incentives for greenfield investment in aspirational districts.
    4. Intellectual property enforcement: Weak enforcement raises the risk premium on technology intensive investment. Eg. India remains on the United States Priority Watch List on intellectual property enforcement. Fix. Create dedicated commercial intellectual property benches with fixed disposal timelines.
    5. Clearance friction across governments: A central approval does not deliver the state permissions a project actually needs. Eg. The National Single Window System still does not carry every state level clearance. Fix. Make full state onboarding to the single window a condition for central infrastructure co-funding.

    Back2Basics: Department for Promotion of Industry and Internal Trade

    1. Parent ministry: It sits under the Ministry of Commerce and Industry. It was the Department of Industrial Policy and Promotion until internal trade was added in 2019.
    2. Policy mandate: It frames and administers the Consolidated FDI Policy and issues the Press Notes that amend it.
    3. Programmes run: It runs Startup India and Make in India, and maintains the National Single Window System.

    “[2020] With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic?

    (a) It is the investment through capital instruments essentially in a listed company.

    (b) It is a largely non-debt creating capital flow.

    (c) It is the investment which involves debt-servicing.

    (d) It is the investment made by foreign institutional investors in the Government securities.

  • RBI to close FCNR(B) concessional swap window a month early on August 31

    Why in the News

    The Reserve Bank of India (RBI) will close its concessional Foreign Currency Non-Resident Bank (FCNR(B)) deposit swap facility on 31 August, ahead of the original 30 September deadline. The facility has already mobilised $52.3 billion.

    How does the facility work?

    • Dollar-rupee swap: Banks exchange foreign currency for rupees with RBI and reverse the transaction later at a pre-agreed rate.
    • RBI absorbs the hedging cost, making FCNR(B) deposits more attractive.
    • Helps banks manage exchange-rate risk while adding foreign currency resources to India.

    What is FCNR(B)?

    • Foreign Currency Non-Resident Bank deposit: Term deposit held by a Non-Resident Indian (NRI) in a permitted foreign currency.
    • Principal and interest are repaid in the same foreign currency, so the depositor bears no exchange-rate risk.

    Why was the facility closed early?

    • Announced on 5 June and operational from 8 June.
    • Mobilised $52.3 billion by 13 August.
    • Banks expect around $20 billion more by month-end.
    • RBI considered the response sufficient and further mobilisation unnecessary.

    Key Risks

    • Asset-liability mismatch: Deposits may mature together while assets have different maturities.
    • Rollover risk: Banks need foreign currency when deposits mature.
    • Reversibility: FCNR(B) deposits are debt creating and can leave at maturity.
    • Currency risk: RBI assumes the hedging risk under the concessional swap.
    • Deployment mismatch: Foreign currency raised must find suitable foreign currency assets or be swapped.
    • Underlying external imbalance: Such inflows can temporarily ease pressure without addressing structural current account pressures.

    “[2021] Consider the following:
    1. Foreign currency convertible bonds
    2. Foreign institutional investment with certain conditions
    3. Global depository receipts
    4. Non-resident external deposits
    Which of the above can be included in Foreign Direct Investments?
    (a) 1, 2 and 3
    (b) 3 only
    (c) 2 and 4
    (d) 1 and 4

  • The rupee’s borrowed breathing space

    Why in the News

    Banks mobilised $52.3 billion in foreign currency inflows between 8 June and 13 August under the Reserve Bank of India (RBI) special swap facility, with Foreign Currency Non Resident Bank, or FCNR(B), deposits accounting for the bulk of the funds. The RBI closed the swap window a month earlier than scheduled, and the rupee fell to a 17 day low of 95.61 against the dollar the same day. A country can defend its currency by earning dollars or by borrowing them, and this stabilisation belongs to the second kind.

    How does the RBI special swap facility for FCNR(B) deposits work?

    1. The deposit: FCNR(B) deposits let non resident Indians hold foreign currency with Indian banks, free of rupee risk, with tax free interest and full repatriation.
    2. Step one, raising the money: Banks raise fresh deposits of three to five year maturity in foreign currency.
    3. Step two, the swap: Banks swap those dollars with the RBI in exchange for rupees.
    4. Step three, the subsidy: The central bank absorbs the hedging cost of that swap, which is the cost banks would otherwise pay to protect themselves against currency movement.
    5. The result for the depositor: Once the cost is lifted, banks can offer dollar rates near 6 to 7.5 per cent, and some add leverage of 9 to 19 times.
    6. The nature of the transaction: For a wealthy depositor borrowing abroad and placing the proceeds in India at a protected high yield, this is a carry trade with the currency risk removed by someone else.

    What is a carry trade?

    1. About: A carry trade is borrowing in a currency where interest rates are low and investing in an asset that pays a higher return, keeping the difference between the two rates.
    2. The risk it normally carries: The lender bears the exchange rate risk, since a fall in the investment currency can wipe out the interest gain.
    3. What is different here: The currency risk is removed by the central bank absorbing the hedging cost, so the investor keeps the yield without the exposure that usually pays for it.

    What is a hedging cost in a currency swap?

    1. About: A currency swap exchanges one currency for another today with an agreed reversal at a future date and a pre agreed rate.
    2. The cost: The hedging cost is the price of that future certainty, set mainly by the interest rate difference between the two currencies and by expectations of depreciation.
    3. Who pays it here: The RBI absorbs it, which is why the transaction is a subsidy rather than a market clearing price.

    What is an asset liability mismatch?

    1. About: An asset liability mismatch arises when a bank’s borrowings and its lending differ in currency, maturity or interest rate basis.
    2. The form it takes here: Banks raise three to five year foreign currency money and lend against it in rupees on different terms, so repayment obligations and asset returns do not move together.

    What did the swap window actually mobilise?

    1. The headline number: Banks mobilised $52.3 billion in foreign currency inflows between 8 June and 13 August under the facility.
    2. The composition: FCNR(B) deposits accounted for the bulk of the funds raised.
    3. Early closure: The RBI closed the FCNR(B) swap window a month earlier than originally scheduled.
    4. The immediate market reaction: The rupee depreciated 0.2 per cent to close at a 17 day low of 95.61 against the dollar, the worst performing currency in Asia that day despite a softer dollar.
    5. The added pressure: A rise in crude oil prices to nearly $90 a barrel compounded the fall, with importers rushing to take forward cover and exporters holding back dollar sales.
    6. The intervention: Intervention by the central bank prevented a sharper slide.

    Why did the money need such inducement?

    1. The prior position: Confidence had already left, since the rupee was Asia’s worst performing currency in the financial year 2025 to 2026.
    2. The portfolio exit: Foreign portfolio investors had pulled out billions from Indian markets over that period.
    3. The partial return: They turned net buyers in July, bringing in about $2.1 billion, a modest reversal relative to the scale of the preceding exodus.
    4. The reading that follows: It is too early to read this as investors rediscovering India.
    5. The revealing detail: The money recorded a sharp fall as soon as the inducement was withdrawn, which measures the incentive rather than belief in Indian assets.

    Why does a subsidy work when good data does not?

    1. The nature of currency markets: Currency markets move not only on fundamentals but on expectations about future movement.
    2. The trap of one way expectations: Once investors believe depreciation is one way, good data stops persuading them.
    3. The mechanism that breaks the loop: The way to break that loop is to make the bet against the rupee expensive, which is what the FCNR(B) window does.
    4. The price of the fix: Flows surged only after the subsidy appeared, so the pace of mobilisation measures the incentive.
    5. The conclusion drawn: Confidence that materialises only after the price is raised is not confidence, it is a purchase.

    What has India actually bought?

    1. The two ways to defend a currency: A country can earn more dollars or it can borrow them, and the two look alike when the money arrives.
    2. The category this falls into: India’s latest external sector stabilisation largely falls into the borrowing kind.
    3. What was purchased: India has bought time, and a quiet transfer of risk.
    4. The repayment obligation: These deposits will mature, and every dollar arriving now must be repaid in three to five years.
    5. The correct classification: The surge is best viewed as a balance of payments stabiliser rather than a durable source of dollars.
    6. The accounting reality: FCNR(B) deposits are ultimately a form of external borrowing and create future repayment and rollover obligations.

    Where does the risk actually sit?

    1. The scheme does not remove risk: The facility does not make the rupee’s risk disappear, it relocates it.
    2. The first relocation: When the RBI absorbs hedging costs, the exposure moves onto the public balance sheet.
    3. The second relocation: When banks raise three to five year money and lend against it, the risk resurfaces as an asset liability mismatch.
    4. The transformation over time: A visible currency problem today can become a less visible banking problem tomorrow.
    5. Who ultimately holds it: The depositor keeps a protected yield, and the currency exposure that yield was compensating for sits with the central bank and the banking system.

    What is genuinely not in crisis?

    1. Reserves: India’s foreign exchange reserves are large, giving the central bank room to intervene in the spot and forward markets.
    2. Invisible earnings: Services exports and remittances cushion the external account against a goods trade deficit.
    3. External factors: Part of the rupee’s weakness reflects the strength of the dollar rather than a domestic failure.
    4. The correct qualification: Being out of crisis is not the same as being secure.
    5. The deterioration that matters: India slipped into a current account deficit in May, which is the backdrop against which the FCNR(B) surge must be read.

    What should India do with a window it has paid to open?

    1. Treat it correctly: Treat the period as a purchased pause and spend it well, rather than as evidence that the external problem has been solved.
    2. Build export surplus sectors: Develop sectors that earn a durable dollar surplus rather than relying on capital inflows to balance the account.
    3. Attract foreign direct investment: Draw investment that takes a lasting stake, since it does not carry a fixed repayment date the way a deposit does.
    4. Cut energy import dependence: Reduce the largest single item of the import bill, which is also the most exposed to geopolitical shocks.
    5. Treat tourism as a foreign exchange industry: Recognise inbound tourism as an export earning activity and plan for it accordingly.
    6. The blunt limit: If India earns too few dollars, no better way of borrowing will solve it.

    Challenges in managing India’s external sector

    1. Rollover risk on maturing deposits: Large foreign currency deposits raised in one window fall due together and must be repaid or renewed at whatever rate then prevails. e.g. the $34 billion of FCNR(B) deposits raised under the 2013 swap window created a concentrated redemption in 2016 that the RBI had to manage in advance.
    2. Oil price exposure: India imports the overwhelming share of its crude oil, so the trade deficit moves with a price it does not set. e.g. crude near $90 a barrel in August 2026 directly widened the import bill and pressured the rupee.
    3. Gold import demand: Household demand for gold converts savings into imports and worsens the current account. e.g. gold has repeatedly been the second largest item in India’s import bill after crude oil.
    4. Volatility of portfolio flows: Foreign portfolio investment can reverse within weeks on a change in global interest rates. e.g. the taper announcement of 2013 triggered an exit that took the rupee past 68 to the dollar.
    5. Narrow export basket and market concentration: A few products and a few destinations carry a large share of merchandise exports. e.g. tariff action by a single large trading partner can hit textiles, gems and jewellery and shrimp exports simultaneously.
    6. Rising import intensity of exports: Electronics and refined petroleum exports require heavy imported inputs, so gross export growth adds less net foreign exchange. e.g. smartphone exports rely on imported displays, camera modules and cells.
    7. Sterilisation cost of intervention: Defending the rupee by selling dollars injects rupee liquidity that must then be absorbed at a cost. e.g. the RBI uses open market operations and the standing deposit facility to drain the liquidity created by intervention.
    8. External debt servicing: A rising stock of short term external debt raises the share of reserves committed to repayment. e.g. short term debt on residual maturity has at times exceeded a fifth of foreign exchange reserves.

    Conclusion

    The $52.3 billion mobilised under the swap window is borrowed rather than earned, and the currency risk that made it attractive has been moved onto the public balance sheet and into bank balance sheets. The central bank acted decisively and bought time, and every dollar of that time must be repaid within three to five years. What remains unresolved is the underlying position, since India slipped into a current account deficit in May and the flows arrived only after the price was raised. Rupee stability now rests increasingly on liabilities the country has paid to attract and must one day repay.

    What is the Balance of Payments?

    1. About: The balance of payments is the systematic record of all economic transactions between residents of a country and the rest of the world over a period.
    2. Rationale: It exists to show whether a country is paying its way through what it earns, or financing consumption and investment through borrowing and asset sales.
    3. Current account: Records trade in goods and services, primary income such as investment income, and secondary income such as remittances.
    4. Capital and financial account: Records foreign direct investment, portfolio investment, external commercial borrowing, banking capital including non resident deposits, and reserve movements.
    5. Errors and omissions: The residual balancing entry that reconciles the two accounts, since the sources for each side differ.
    6. The accounting identity: A current account deficit must be financed by a surplus on the capital account or by drawing down reserves.

    Key Concerns Regarding India’s External Sector Position

    1. Deficit financed by volatile capital: A current account deficit funded by portfolio flows and non resident deposits is more fragile than one funded by foreign direct investment.
    2. Dependence on invisibles: Services exports and remittances mask a persistent and large merchandise trade deficit.
    3. Reserve adequacy measured wrongly: A large absolute reserve stock can still be thin when measured against short term external liabilities on a residual maturity basis.
    4. Commodity price pass through: Oil, gold and fertiliser prices are set abroad, so a large part of the external position is outside domestic policy control.
    5. Rupee internationalisation lag: Almost all of India’s trade is invoiced in dollars, so every trade shock passes directly into demand for foreign exchange.
    6. Contingent liabilities of intervention: Forward market intervention creates future dollar delivery obligations that do not appear in the headline reserve figure.

    Statutory Framework Governing Foreign Exchange and External Borrowing

    1. Entry 36 of the Union List: Places currency, coinage and legal tender, and foreign exchange, exclusively with Parliament.
    2. Entry 37 of the Union List: Covers foreign loans, the constitutional basis for regulating external borrowing.
    3. Section 3 of the Foreign Exchange Management Act, 1999: Prohibits dealing in foreign exchange except through authorised persons.
    4. Section 6 of the Foreign Exchange Management Act, 1999: Governs capital account transactions, including non resident deposits and external borrowing.
    5. Section 47 of the Foreign Exchange Management Act, 1999: Empowers the RBI to make regulations to carry out the provisions of the Act.
    6. Sections 17 and 33 of the Reserve Bank of India Act, 1934: Govern the business the RBI may transact and the assets backing the note issue, including foreign securities.
    7. Preamble to the Reserve Bank of India Act, 1934: States the objective of operating the currency and credit system to the country’s advantage and maintaining price stability.

    Laws and Rules Governing Non Resident Deposits

    1. Reserve Bank of India Act, 1934: Establishes the central bank and its powers over currency, reserves and monetary operations.
    2. Section 45ZB: Provides for the Monetary Policy Committee, which sets the policy rate that shapes the interest differential behind a swap.
    3. Foreign Exchange Management Act, 1999: Replaced the Foreign Exchange Regulation Act, 1973 and shifted the regime from control to management of foreign exchange.
    4. Foreign Exchange Management (Deposit) Regulations, 2016: Govern the operation of Non Resident External, Non Resident Ordinary and FCNR(B) accounts.
    5. Banking Regulation Act, 1949: Governs the conduct of banking companies, including the reserve and liquidity requirements applicable to these deposits.
    6. Foreign Exchange Management (Borrowing and Lending) Regulations, 2018: Govern external commercial borrowing and the terms on which residents may borrow abroad.
    7. Prevention of Money Laundering Act, 2002: Applies customer due diligence and reporting requirements to non resident deposit accounts.
    8. Income Tax Act, 1961: Provides the exemption that makes interest on FCNR(B) and Non Resident External deposits tax free for a non resident.

    Back2Basics: Non Resident Deposit Accounts in India

    1. FCNR(B) account: A term deposit held in a permitted foreign currency with an Indian bank, with maturity from one to five years.
    2. Currency risk on FCNR(B): The deposit is denominated in foreign currency, so the depositor faces no rupee depreciation risk and the bank or the central bank carries it.
    3. Non Resident External (NRE) account: A rupee denominated account funded from abroad, fully repatriable, with tax free interest in India.
    4. Non Resident Ordinary (NRO) account: A rupee account for income earned in India such as rent, pension or dividends, with limited repatriation and taxable interest.
    5. Regulatory basis: All three are governed by the Foreign Exchange Management (Deposit) Regulations, 2016 under the Foreign Exchange Management Act, 1999.
    6. Policy use: The RBI periodically relaxes interest rate ceilings and reserve requirements on these deposits to attract dollar inflows when the rupee is under pressure.
    7. Balance of payments classification: Non resident deposits are recorded as banking capital under the capital account, not as current account earnings.

    Government and RBI Initiatives on External Stability

    1. Special swap facility for FCNR(B) deposits: Absorbs the hedging cost of bank dollar deposits to attract diaspora funds during periods of currency pressure.
    2. Special Rupee Vostro Accounts: Allow settlement of international trade in rupees with partner countries, reducing dollar demand for those transactions.
    3. Gold Monetisation Scheme: Brings idle domestic gold into the financial system to cut fresh import demand.
    4. Sovereign Gold Bonds: Provide a paper substitute for physical gold, reducing the import component of gold demand.
    5. Liberalised Remittance Scheme: Sets the annual limit within which resident individuals may remit funds abroad, a control on outflows.
    6. External Commercial Borrowing framework: Sets maturity, cost ceiling and end use conditions for corporate borrowing abroad.
    7. Foreign exchange reserve management: Reserves are held in foreign currency assets, gold, Special Drawing Rights and the reserve tranche position with the International Monetary Fund.

    Key Facts about India’s External Sector

    1. Reserve composition: India’s foreign exchange reserves comprise foreign currency assets, gold, Special Drawing Rights and the reserve tranche position with the IMF.
    2. Remittance rank: India is the largest recipient of inward remittances in the world.
    3. Services strength: India is among the top ten exporters of commercial services globally, led by software and business services.
    4. Import composition: Crude oil and gold are consistently the two largest items in India’s merchandise import bill.
    5. The 2013 precedent: A similar concessional swap window in 2013 raised about $34 billion through FCNR(B) deposits and bank capital during that year’s currency crisis.
    6. Exchange rate regime: India follows a managed float, where the rate is market determined and the RBI intervenes to contain volatility rather than to defend a level.
    7. Convertibility status: The rupee is fully convertible on the current account and only partially convertible on the capital account.

    Way Forward

    1. Sequence the repayment: Publish a maturity profile of the deposits raised and build forward cover ahead of the redemption window rather than at it.
    2. Shift the financing mix: Prioritise foreign direct investment and long term equity flows over interest sensitive deposits as the source of external financing.
    3. Expand export capability: Target sectors with high domestic value addition so export growth adds net foreign exchange rather than gross turnover.
    4. Reduce energy import intensity: Accelerate renewable capacity, ethanol blending and electrification of transport to shrink the crude oil bill.
    5. Widen rupee trade settlement: Extend Special Rupee Vostro arrangements to more trade partners so a larger share of trade avoids dollar intermediation.
    6. Treat tourism as an export sector: Fund visa facilitation, connectivity and destination infrastructure with the same seriousness as merchandise export promotion.
    7. Report the contingent position: Disclose the forward book and swap obligations alongside headline reserves so the true net position is visible.

    Matching Previous Year Question

    “[2015, GS3, 12.5 marks] Craze for gold in Indians have led to a surge in import of gold in recent years and put pressure on balance of payments and external value of rupee. In view of this, examine the merits of Gold Monetization Scheme.”

  • From price taker to price setter: India’s commodity market gains clout

    Why in the News

    The Securities and Exchange Board of India (SEBI) is soliciting public views on allowing Foreign Portfolio Investors (FPIs) into non agricultural, physically settled commodity derivatives covering bullion, energy and base metals. India is a major importer of crude oil, gold and industrial metals, yet it takes prices set on foreign exchanges rather than setting them. The proposal tests whether deeper liquidity turns India into a price setter or imports the volatility of global markets.

    What are physically settled commodity derivatives?

    1. About: A commodity derivative is a contract whose value is derived from an underlying commodity, traded as a future or an option on an exchange.
    2. Physical settlement: A physically settled contract is closed by actual delivery of the underlying goods at expiry, rather than by paying the cash difference between the contract price and the market price.
    3. Why the distinction matters: Physical settlement ties the exchange price to the real warehouse and delivery market, which is what makes a contract usable as a benchmark.
    4. The categories in question: The proposal covers bullion meaning gold, silver and their derivatives, energy meaning crude oil and natural gas, and base metals meaning aluminium, copper, lead, nickel and zinc.
    5. The present bar: Overseas investors are at present not allowed to participate in contracts linked to crude, natural gas, gold or silver that are settled by actual delivery of the underlying goods.

    What is a Foreign Portfolio Investor (FPI)?

    1. About: An FPI is a non resident investor registered with SEBI to invest in Indian securities and financial instruments without acquiring management control.
    2. Distinguishing feature: Portfolio investment is liquid and can exit quickly, unlike foreign direct investment which takes a lasting interest in an enterprise.
    3. Present count: More than 11,000 FPIs are currently registered in India.

    What does price taker versus price setter mean?

    1. Price taker: A market participant large enough to buy in volume, yet whose own trading does not influence the reference price at which the commodity is quoted globally.
    2. Price setter: A market whose exchange price becomes the reference benchmark that buyers and sellers elsewhere quote against.
    3. The stake for India: A price setting market retains benchmark authority, transaction value and hedging activity inside the country instead of exporting them.

    What is Average Daily Turnover (ADT)?

    1. About: Average Daily Turnover is the average notional value of contracts traded per trading day over a stated period, used as the standard measure of an exchange’s activity.
    2. Use here: It is the figure by which the Multi Commodity Exchange (MCX) is compared against global commodity exchanges for depth.

    Why is India a price taker despite being a major importer?

    1. Import weight without market weight: India is a major importer of crude oil, gold and industrial metals, and still has no proportionate influence on how those commodities are priced.
    2. Hedging happens offshore: Domestic commodity risk is currently hedged largely through London, New York, Chicago and Singapore rather than on Indian exchanges.
    3. Missing institutional depth: MCX has strong retail and domestic participation and relatively limited institutional depth compared with global exchanges.
    4. The missing precondition: For India to become a price setter, its domestic commodity market needs integration with the global financial architecture.
    5. The consequence of the gap: Indian users of these commodities accept a price discovered abroad and pay the transaction and collateral cost of using a foreign venue.

    What exactly is SEBI proposing?

    1. The consultation: SEBI is proposing to allow access to foreign portfolio investors into non agricultural derivatives and is seeking public views on the design.
    2. The stated objective: The aim is to bring global commodity risk management into India.
    3. The expected byproduct: Increased depth and liquidity in commodity derivative markets, enabling the country to serve as a global benchmark.
    4. The product scope: Participation is proposed in physically settled contracts in bullion, energy and base metals, the segments that are either imported or globally priced.
    5. The safeguard already stated: SEBI has mandated that such participants square off positions before the delivery period.
    6. The stated challenge: The design problem is to ensure that greater liquidity does not become greater volatility.

    How would onshore hedging change India’s foreign exchange position?

    1. Margin retention: Margin money posted against contracts stays within the country instead of moving to a foreign clearing house.
    2. Brokerage retention: Brokerage paid on the trade remains domestic revenue.
    3. Lower collateral demand on banks: Banks would need less foreign currency for collateral purposes when hedging moves onshore.
    4. What is not saved: India cannot avoid paying dollars for demand inelastic imported commodities, so the total import bill does not fall.
    5. What is saved: The country saves on offshore collateral, transaction costs and financial outflows.
    6. The precise gain: The result is a reduction in the volatility of India’s foreign exchange requirement, not a large reduction in total foreign exchange outflow.

    What multiplier effect do FPIs bring to the domestic market?

    1. The liquidity function: FPIs can create a multiplier effect by providing the liquidity that domestic hedgers need on the other side of their trades.
    2. The hedgers who benefit: Airlines, oil marketing companies (OMCs) and industrial users would be able to hedge efficiently on Indian exchanges.
    3. The scale even at low participation: Of the more than 11,000 registered FPIs, even a tenth participating on a conservative estimate would bring in considerable liquidity.
    4. Benchmark influence: By attracting global capital, Indian exchanges can gradually become more influential in regional price discovery.
    5. Reduced benchmark dependence: A deeper market also cuts India’s dependence on overseas benchmarks for the same commodities.

    What does the MCX data show about the market’s current depth?

    1. Combined turnover: MCX recorded a combined futures and options Average Daily Turnover of Rs 10.5 lakh crore as of the first quarter of FY27.
    2. Rate of growth: The combined futures and options ADT of MCX rose by 238 per cent in the first quarter of FY27.
    3. What the growth reflects: The rise reflects growing investor adoption of commodity derivatives for both hedging and trading.
    4. Client base: The active client base almost doubled year on year to 13.72 lakh in the review period.
    5. Registered foreign investors: More than 11,000 FPIs are already registered in India across asset classes.
    6. Composition advantage: MCX is dominated by commodities that are either imported or globally priced, which is why the proposal is expected to benefit it most.
    7. The positioning goal: The change is expected to expand MCX’s addressable market and strengthen its position as an Asian commodity trading hub.

    How did the present proposal evolve from earlier reform?

    1. The origin: The seeds of the present proposal were sown in 2015, at the time of the merger of the Forward Markets Commission with SEBI.
    2. The approach since: SEBI has taken measured steps in developing the commodity derivatives market in an orderly manner.
    3. The products introduced: SEBI introduced futures on commodity indices, options on commodity futures, and options in goods.
    4. The stated purpose of those products: To attract broad based participation, enhance liquidity, facilitate hedging and bring more depth to the commodity derivatives market.
    5. Who took them up: The products launched by the exchanges are witnessing substantial trading volumes, driven by mutual funds, alternate investment funds and portfolio management services.
    6. The earlier foreign access route: Eligible Foreign Entities (EFEs) were initially allowed to participate only for hedging, and only if they had direct exposure to Indian physical commodities.
    7. Why that route failed: The response of eligible foreign entities was woefully low, due to operational complexities in the eligibility and compliance design.

    What does the single international precedent cited actually establish?

    1. The one study relied upon: SEBI cites a study of China, which found a jump in volume and in the number of deals after internationalisation of its futures markets.
    2. The cost finding: That study also found trading cost was largely unaffected by the entry of foreign participants.
    3. The inference drawn: SEBI reasoned from this evidence for the entry of FPIs into Indian commodity derivatives.
    4. The limit of the evidence: A single country study of volume and cost does not establish that benchmark authority shifted, which is the outcome India is actually seeking.
    5. The offshore venues that matter: The benchmarks India competes against sit in London, New York, Chicago and Singapore, and none of those cases is examined in the proposal.

    Does deeper liquidity buy price setting power or imported volatility?

    1. The reform is significant: Widening access for FPIs into non farm commodity derivatives is a significant step towards market depth.
    2. The speculation risk: Speculation may amplify price movements in an already charged geopolitical environment, with currency fluctuations and supply disruptions.
    3. Position concentration: Large international commodity trading houses and hedge funds could accumulate significant positions and influence short term prices.
    4. The partial safeguard: SEBI has mandated such participants to square off positions before the delivery period, which limits delivery squeezes but not price influence during the contract’s life.
    5. Contagion channel: Indian commodity markets may sway to Federal Reserve policy and dollar movements once foreign capital is a large presence.
    6. Financialisation risk: Excessive financialisation of commodities may create a discord between futures prices and physical market realities.
    7. The central trade off: The same foreign capital that gives India benchmark weight also transmits foreign monetary policy into domestic commodity prices.

    Challenges to opening commodity derivatives to foreign portfolio investors

    1. Volatility transmission to consumer prices: Commodity futures prices feed into fuel and metal costs that households and industry pay. e.g. a spike in crude futures during the Strait of Hormuz disruption of 2026 pushed the Indian crude basket towards $90 a barrel.
    2. Warehousing and delivery infrastructure: Physical settlement needs accredited warehouses, assaying and quality certification at scale. e.g. the National Spot Exchange Limited payment crisis of 2013 arose from unverified underlying stocks in warehouses.
    3. Regulatory arbitrage with offshore venues: Participants can shift between Indian and foreign contracts to exploit margin and tax differences. e.g. Indian single stock and index derivative volumes migrated to Singapore before the exchanges restructured their offshore licensing.
    4. Currency convertibility limits: The rupee is not fully convertible on the capital account, which constrains how freely foreign hedgers can move funds. e.g. offshore participants continue to use non deliverable forward markets for rupee exposure.
    5. Concentration and manipulation risk: A few large global houses dominate physical trade in several of these commodities. e.g. global metal trading is concentrated among a small number of houses whose positions can move benchmark prices.
    6. Retail exposure to a wholesale market: Indian commodity exchanges have unusually high retail participation for a risk transfer market. e.g. the active client base at MCX almost doubled to 13.72 lakh in a single year.
    7. Agricultural spillover through sentiment: Even with farm contracts excluded, financialisation shapes expectations across commodity classes. e.g. futures trading in seven agricultural commodities was suspended in 2021 over inflation concerns and the suspension was extended repeatedly.

    Conclusion

    India buys crude oil, gold and base metals in global volume and still accepts a price discovered on exchanges abroad, and the proposal to admit FPIs is an attempt to relocate that price discovery onshore. The measurable gain is narrower than the framing suggests, since it lowers the volatility of India’s foreign exchange requirement and retains margin, brokerage and collateral, without reducing the dollar bill for demand inelastic imports. What remains unresolved is whether the same foreign capital that supplies depth also imports Federal Reserve policy and dollar movements into Indian commodity prices. The proposal is at the public consultation stage, and the design question SEBI must answer is how to ensure greater liquidity does not become greater volatility.

    Commodity Derivatives Market in India

    1. About: A commodity derivatives market allows producers, importers and consumers to lock in a future price for a commodity, transferring price risk to participants willing to bear it.
    2. The two functions: The market performs price discovery, by aggregating expectations into a single quoted price, and risk management, by allowing hedging against adverse price movement.
    3. Regulatory history: Commodity derivatives were regulated by the Forward Markets Commission under the Forward Contracts (Regulation) Act, 1952 until the Commission merged with SEBI in 2015.
    4. The exchanges: MCX dominates non agricultural commodities, while the National Commodity and Derivatives Exchange (NCDEX) is the principal agricultural commodity exchange.
    5. India’s scale: India is the world’s largest consumer of gold after China, the third largest consumer and importer of crude oil, and a leading consumer of silver and base metals.
    6. The structural weakness: Institutional and foreign participation is thin, so Indian contracts track international benchmarks rather than generating them.
    7. The newer venue: The India International Bullion Exchange at GIFT City was created to route bullion imports through an organised exchange platform.

    Statutory Framework Governing Commodity Derivatives

    1. Entry 48 of the Union List: Places stock exchanges and futures markets exclusively within Parliament’s legislative competence.
    2. Securities Contracts (Regulation) Act, 1956, Section 2(bc): Defines a commodity derivative, brought in by the Finance Act, 2015.
    3. SEBI Act, 1992, Section 11: Sets out SEBI’s duty to protect investors and to regulate the securities market, extended to commodity derivatives after the merger.
    4. Finance Act, 2015: Repealed the Forward Contracts (Regulation) Act, 1952 and transferred regulation of commodity derivatives to SEBI.
    5. Foreign Exchange Management Act, 1999, Section 6: Governs capital account transactions, the route through which foreign participation and collateral flows are controlled.
    6. Essential Commodities Act, 1955: Empowers the Union to regulate production, supply and trade in notified essential commodities, including suspension of futures trading.

    Laws and Rules Governing Commodity Market Participation

    1. Securities Contracts (Regulation) Act, 1956: Governs recognition of stock exchanges and the legality of contracts in securities and commodity derivatives.
    2. Section 2(bc): Introduced the statutory definition of a commodity derivative in 2015.
    3. SEBI Act, 1992: Establishes SEBI with powers of investigation, adjudication and penalty across securities and commodity derivative markets.
    4. SEBI (Foreign Portfolio Investors) Regulations, 2019: Set out registration categories, eligibility and investment conditions for foreign portfolio investors.
    5. Foreign Exchange Management Act, 1999: Governs the cross border movement of funds, margins and collateral by foreign participants.
    6. Foreign Exchange Management (Debt Instruments) Regulations, 2019: Regulate FPI access to Indian debt, the parallel route to their equity access.
    7. Warehousing (Development and Regulation) Act, 2007: Establishes the Warehousing Development and Regulatory Authority and the negotiable warehouse receipt system that underpins physical settlement.
    8. Essential Commodities Act, 1955: Provides the power under which futures trading in specific commodities has been suspended.
    9. Prevention of Money Laundering Act, 2002: Applies know your customer and reporting obligations to intermediaries handling foreign participant funds.

    Back2Basics: Multi Commodity Exchange of India (MCX)

    1. What it is: MCX is India’s largest commodity derivatives exchange, dealing mainly in bullion, energy and base metals.
    2. Regulator: Regulated by SEBI under the Securities Contracts (Regulation) Act, 1956 since the 2015 transfer of commodity market regulation.
    3. Year of operations: Began operations in 2003 and became India’s first listed commodity exchange.
    4. Product range: Offers futures and options in gold, silver, crude oil, natural gas, aluminium, copper, lead, nickel, zinc, cotton and other commodities.
    5. Index products: Operates commodity indices such as iCOMDEX, on which index futures are traded.
    6. Settlement types: Runs both cash settled and physically settled contracts, with delivery through accredited warehouses and vaults.
    7. Current scale: Combined futures and options average daily turnover reached Rs 10.5 lakh crore in the first quarter of FY27, with an active client base of 13.72 lakh.

    Government Initiatives Related to Commodity Markets

    1. Merger of the Forward Markets Commission with SEBI: Unified regulation of securities and commodity derivatives under a single regulator from 2015.
    2. India International Bullion Exchange at GIFT City: Created to channel bullion imports through a regulated exchange and build a domestic gold price benchmark.
    3. Gold Monetisation Scheme: Mobilises idle household and institutional gold into the banking system to reduce fresh import demand.
    4. Sovereign Gold Bonds: Offer a paper alternative to physical gold holding, reducing import linked demand.
    5. Electronic Negotiable Warehouse Receipts: Issued under the Warehousing Development and Regulatory Authority framework to make stored commodities financeable and deliverable.
    6. Electronic National Agriculture Market (eNAM): Creates a unified electronic spot market for agricultural produce across regulated mandis.
    7. International Financial Services Centres Authority: Regulates the unified financial services centre at GIFT City, including commodity and bullion derivatives available to non residents.

    Key Facts about India’s Commodity Market

    1. Regulator: SEBI, since the Forward Markets Commission merged into it on 28 September 2015.
    2. Repealed statute: The Forward Contracts (Regulation) Act, 1952 was repealed through the Finance Act, 2015.
    3. Principal exchanges: MCX for non agricultural commodities and NCDEX for agricultural commodities.
    4. Gold consumption: India is among the two largest gold consuming countries in the world, with imports a major component of its current account deficit.
    5. Crude dependence: India imports well over 85 per cent of its crude oil requirement, which is why energy contracts dominate hedging demand.
    6. Institutional access built in stages: Mutual funds, alternate investment funds and portfolio management services were allowed into commodity derivatives before foreign portfolio investors.
    7. Physical settlement mandate: SEBI moved several non agricultural contracts to compulsory delivery based settlement to align futures prices with physical markets.

    Challenges in India’s Commodity Derivatives Market

    1. Shallow institutional participation: Banks, insurers and pension funds are largely absent from commodity hedging. e.g. Indian banks are not permitted to take proprietary positions in commodity derivatives the way global banks do.
    2. Fragmented physical markets: Spot markets remain dispersed and unstandardised, weakening the link between futures and delivery. e.g. agricultural produce market committee mandis quote different grades and prices for the same crop within one State.
    3. Policy reversals: Sudden suspension of contracts undermines confidence in the market as a hedging venue. e.g. futures trading in seven agricultural commodities including wheat, mustard and chana was suspended in December 2021.
    4. Tax and transaction cost: Commodity transaction tax and stamp duty raise the cost of trading relative to offshore venues. e.g. Indian participants have historically routed positions through Dubai and Singapore for cost reasons.
    5. Quality assaying and standardisation: Delivery requires reliable and uniform quality certification. e.g. bullion delivery requires refiners accredited to internationally recognised good delivery standards, which few Indian refiners hold.
    6. Investor protection in a leveraged market: Retail participants trade leveraged contracts they may not fully understand. e.g. the negative settlement of crude oil futures in April 2020 imposed large losses on Indian retail participants holding long positions.
    7. Weak farmer linkage: The agricultural segment does not reach the producers it is meant to protect. e.g. participation by farmer producer organisations in agricultural futures remains a very small share of turnover.

    Way Forward

    1. Phase the entry with position limits: Admit foreign portfolio investors in stages with commodity wise position limits, so liquidity builds without allowing concentrated control of a contract.
    2. Strengthen surveillance: Build cross market surveillance linking futures positions with warehouse stocks and physical trade data to detect manipulation early.
    3. Deepen delivery infrastructure: Expand accredited warehouses, vaults and assaying laboratories so physical settlement scales with volume.
    4. Allow domestic institutional hedgers: Permit banks, insurers and pension funds calibrated access, so foreign capital is not the only source of institutional depth.
    5. Stabilise policy: Commit to a rule based framework for suspending a contract, so intervention is predictable rather than discretionary.
    6. Rationalise transaction cost: Review the commodity transaction tax and stamp duty structure to remove the incentive to hedge offshore.
    7. Extend hedging to the producer: Support aggregation through farmer producer organisations and small industry associations so hedging reaches beyond large firms.

    Matching Previous Year Question

    “[2021] Consider the following:
    1.Foreign currency convertible bonds
    2.Foreign institutional investment with certain conditions
    3.Global depository receipts
    4.Non-resident external deposits
    Which of the above can be included in Foreign Direct Investments?
    (a) 1, 2 and 3
    (b) 3 only
    (c) 2 and 4
    (d) 1 and 4
    Answer: (a)”