|
Getting your Trinity Audio player ready...
|
Indian banks have quietly left much of the future interest payments on more than $127 billion in overseas foreign currency deposits unhedged, according to five bankers who spoke to Reuters, a gap that could become a genuine source of dollar demand and add fresh depreciation pressure on the rupee if currency conditions turn unfavorable. It’s the kind of risk that doesn’t show up in headline currency data today but has the potential to compound sharply if the rupee starts weakening again, precisely the scenario Indian policymakers have spent much of 2026 trying to avoid.
The deposits at the center of this story trace back to June, when the Reserve Bank of India opened a special swap facility as part of a broader set of one-off measures designed to strengthen India’s balance of payments, a response to surging oil prices that had put sustained pressure on the currency. Lenders have since raised more than $127 billion through these Foreign Currency Non-Resident, or FCNR(B), deposits, a figure that substantially exceeded the central bank’s own initial estimate of roughly $80 billion. Once overseas commercial borrowings and foreign-currency debt are added in, total inflows through this window climbed to $136.38 billion, according to reporting on the programme’s scale, a genuinely large pool of dollars that gave the RBI considerably more firepower to defend the rupee than originally anticipated.
Understanding the actual risk here requires separating two very different pieces of these deposits. On the principal amount, banks are fully protected, since the RBI’s special swap facility explicitly shields lenders from currency risk on that core deposit value. Interest payments are an entirely different matter. Under the arrangement, banks are individually responsible for managing the currency risk tied to interest owed on these deposits, and according to the bankers who spoke to Reuters, a substantial share of that interest exposure has simply been left unhedged. That distinction matters enormously, because while the principal protection keeps the headline deposit programme sound, the unhedged interest component creates a separate, quieter source of future dollar demand that isn’t currently reflected in how markets are pricing the rupee.
The reason banks have left this exposure unhedged comes down almost entirely to cost. According to bankers familiar with the situation, hedging FX risk on interest payments for deposits with three- to five-year tenors, where interest gets paid in full at maturity rather than periodically, currently costs roughly 3 percent annually. That’s a meaningful expense to carry across a deposit book measured in the tens of billions of dollars, and the head of FX trading at one private-sector bank described the hedging cost as prohibitive given how the RBI’s own recent intervention has reshaped the underlying risk calculation. According to that trader, persistent central bank support has made the risk-reward profile on the rupee genuinely asymmetrical right now, meaning positive developments are considerably more likely to trigger a sharp rupee rally than negative news is to meaningfully weigh the currency down. In an environment where that asymmetry holds, paying 3 percent annually to hedge against a downside scenario many bankers currently view as less probable starts to look like an expensive insurance policy against a risk the market isn’t pricing very highly.
That calculation, reasonable as it might look in the current environment, is exactly what creates the overhang risk analysts are now flagging. If conditions shift, whether through renewed oil price pressure, a broader dollar strengthening cycle, or some other shock that pushes the rupee toward depreciation, banks holding unhedged interest exposure on more than $127 billion in deposits would suddenly need to source dollars to cover those payments precisely at the moment when dollar demand is already climbing across the broader market. That kind of simultaneous, compounding dollar demand, arriving right as the currency is already under pressure, is the specific mechanism through which an FX risk decision that looks sensible today could turn into a meaningful depreciation accelerant tomorrow.
For now, the picture actually looks favorable for the rupee. The currency climbed to a two-month high this week amid persistent RBI intervention, with analysts specifically crediting the additional firepower the overseas FX deposit programme has given the central bank as a contributing factor to that strength. That’s worth sitting with for a moment, since it illustrates the somewhat paradoxical nature of this entire situation: the same deposit programme that’s currently helping support the rupee through added RBI intervention capacity also carries, buried within its interest payment structure, a latent source of future dollar demand that could work against the currency if sentiment ever reverses.
This isn’t the first time in 2026 that RBI-directed currency management has created unintended positioning risk within India’s banking system. Back in April, the central bank moved to crack down on corporate arbitrage trades that had grown lucrative and low-risk, directing banks to unwind positions estimated at $30 billion to $40 billion. Only about half to 60 percent of those positions were actually unwound in the initial push, leaving what bankers at the time described as a substantial overhang in the system, one that contributed to the rupee briefly slipping to an all-time low of 95.21 against the dollar. Kunal Sodhani, head of treasury at Shinhan Bank, characterized that episode as part of a clear, coordinated shift by the RBI toward tightening speculative activity and reasserting control over rupee dynamics, a description that arguably applies just as well to the current FX deposit hedging situation, even though this time the unhedged exposure sits with banks managing legitimate deposit-taking activity rather than corporates exploiting arbitrage loopholes.
Whether this particular overhang ever actually materializes into meaningful rupee pressure depends heavily on factors well outside any individual bank’s control, oil prices, broader dollar strength, and whatever comes next from a Federal Reserve that’s already been reshaping global currency markets through its own policy signals this year. What’s clear for now is that Indian banks have made a calculated economic decision to accept currency risk they could have hedged away, betting that the cost of protection outweighs a probability-weighted downside they currently see as relatively remote, a bet that will only be tested if and when the rupee’s current stability actually breaks.
Further detail on India’s foreign currency deposit programme is available through the Reserve Bank of India’s official communications. For more coverage of global currency markets and emerging market central bank policy, visit Business Tech.
