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Uday Kotak, founder and non-executive director of Kotak Mahindra Bank, on Monday described the foreign currency non-resident (bank), or FCNR(B), scheme as a “strong insurance policy” for India amid global macroeconomic and geopolitical uncertainty. He also cautioned that the country must prepare for the eventual repayment of the foreign currency deposits raised under the scheme.
“I have no hesitation in saying that what India’s policymakers between RBI and the government did was the right thing in the context of the global macroeconomic and geopolitical situation, with the world facing the Middle East conflict on top of the Russia-Ukraine conflict. I think of the FCNR(B) scheme as a strong insurance policy,” he said.
In his address, Kotak said the FCNR(B) scheme had given India three to five years to strengthen its macroeconomic and financial position. However, he cautioned that the deposits would eventually mature, requiring the country to prepare for the repayment.
He estimated that India would have to repay more than $130 billion raised under the scheme, along with interest, taking the total repayment obligation to around $160-170 billion.
“We don’t need to panic about it today, but we must be strategic about it. We need to build India’s economic and financial structure for that time, which will inevitably come,” Kotak said.
India locked in foreign currency deposits before yields rose
Kotak said India had raised foreign currency deposits before US bond yields rose sharply in September, helping it secure the funds at a relatively lower cost.
“The US bond yields went up sharply in the first week of September, and the five-year and 10-year bonds crossed 5 per cent after September. India borrowed its money in fixed-rate US dollars well before the sharp spike in yields,” he said. “Therefore, India locked in foreign currency deposits relatively cheaper, and today it would probably have cost us at least 100 basis points more.”
He also raised concerns about the difference between returns on US government bonds and Indian government securities after accounting for currency hedging costs.
Kotak said the US 10-year Treasury yield was around 5 per cent, while hedging the dollar exposure into rupees would cost about 3.5 per cent annually. This would take the hedged return to around 8.5 per cent in rupee terms, compared with a yield of approximately 7.4 per cent on India’s 10-year government security.
“The arbitrage favours foreign currency versus domestic interest rates,” he said, adding that the differential was an issue for financial market participants and policymakers to consider.
Kotak said global geopolitical tensions and inflation had pushed interest rates higher across markets. India’s 10-year government security yield had also risen by around 75-80 basis points, he added.
Domestic savings and foreign investor outflows
Kotak also raised concerns about the difference in tax treatment between capital gains and interest income, saying it was influencing how domestic investors allocated their savings.
He said the effective capital gains tax rate for domestic investors was around 14.95 per cent, including surcharge and other charges, while the tax rate on interest income for large individual investors could reach 39 per cent.
“This is a very wide gap, and therefore, from the point of view of post-tax returns, it is moving Indian investors, especially those with surpluses, towards capital gains-related instruments,” he said.
Kotak said this shift was putting pressure on demand for interest-bearing instruments, including deposits, while directing more domestic savings towards equity-oriented investments.
He also drew attention to the contrast between foreign portfolio investors selling Indian assets and domestic investors continuing to invest in the market.
“At one level, the Indian investor is the counterpoint as foreign flows happen. At another level, the Indian investor, directly or indirectly, is giving exit to the foreigners, and I’m not against that. It’s free markets. We must respect that,” he said.
Kotak estimated that foreign portfolio investors held around $700 billion worth of Indian assets. Including foreign direct investment, he put the total stock at approximately $1.5 trillion.
He said India needed to consider the relationship between domestic tax structures, interest rates and capital gains, as foreign investors ultimately repatriate their proceeds in dollars.
Gold imports add to external account pressures
Kotak also raised concerns about gold imports and their implications for India’s current account and currency markets.
He said India’s current account position would be in surplus if gold imports were excluded, citing a current account deficit of $26 billion for the financial year ending March 2026 against gold imports of $72 billion.
For the financial year ending March 2027, he said gold imports could reach $90 billion, while oil imports could be in the range of $60-65 billion. He cautioned that continued gold imports, combined with pressure on portfolio flows, could weigh on the rupee.
Kotak said Indian households had a right to hold gold, but the country’s dependence on gold imports required strategic consideration.
He also argued that India needed to strengthen its economic position over the next three to five years and build sectors that could meet global demand.
“I am bullish on India in the long term,” he said, adding that the country needed a strategy to address its macroeconomic challenges.
“I am a deep believer that India will get it right. The time for that is for us to have a strategy, both as practitioners to be awake to the reality of what’s happening, and from a policy point of view, a strategic, structural answer to some of the challenges to our macroeconomy,” Kotak said.
(Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt. Ltd.)
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