Why efficiency of capital, not its volume, matters more for India
When foreign investment or India’s foreign-exchange reserves rise, the numbers are usually presented as a sign of economic strength. The more important question is not whether foreign capital enters India, but whether it creates enough productive capacity to meet the claims it leaves behind. See infographics.
India needs to aim for better foreign capital than just more of it. (File) — Pushpendra Singh and Archana Singh
The Reserve Bank of India (RBI) has drawn $143.596 billion in foreign currency inflows under its special US dollar-rupee forex swap facility, with Foreign Currency Non-Resident (Bank), or FCNR(B), deposits accounting for the overwhelming share of the mobilisation.
The facility was introduced in June and aimed at attracting fresh foreign currency inflows into the banking system. While India needs overseas capital to finance investment in infrastructure, technology, and productive capacity, the challenge is to attract productive capital without weakening the economy’s ability to withstand its exit.
But not all foreign currency is productive capital in the same sense. Foreign Direct Investment (FDI), foreign borrowing, NRI deposits, and the RBI’s reserves are not the same. Whenever foreign investment or India’s foreign-exchange reserves rise, the numbers are presented as a sign of economic strength.
But does every dollar entering India strengthen it the same way? Is money borrowed abroad the same as an investment in a factory? Are RBI reserves resources that can be freely used by the government? First, let’s understand the need for foreign capital.
How India Raises Foreign Capital — And Who Owes What
Why India needs foreign capital
Domestic savings finance much of India’s investment, but they are not always available in the required scale or form. Infrastructure, semiconductor plants, clean energy, and digital networks require large, long-term investments and specialised technology.
Foreign capital can supply these. But every inflow creates a future claim. Equity investors expect dividends and capital gains and lenders expect interest and repayment. The portfolio investors expect to be able to sell and repatriate their money.
Therefore, the more important question is not whether foreign capital enters India, but whether it creates enough productive capacity to meet the claims it leaves behind. The answer in part lies in the form the capital takes and the way it is used.
How businesses raise capital
There are various channels through which businesses can raise capital, and each source carries its distinct benefits and future obligations.
FDI
Foreign Direct Investment (FDI) is generally the most stable route for capital flows. A multinational may construct a factory, establish a subsidiary, or acquire a substantial stake in the Indian business. In addition to money, FDI can bring technology, skills and access to export networks.
According to the RBI data, India received total FDI inflows of $94.53 billion in the first quarter of FY 2025-26, but the net figure was a mere $7.65 billion. Therefore, gross FDI is not the same as net FDI retained. Net FDI is calculated after adjusting gross FDI for investments that are repatriated by foreign companies and overseas investments made by Indian companies.
A new factory adds productive capacity, whereas the purchase of an existing company may largely change ownership. To assess the net contribution of foreign capital, therefore, capital outflows, including disinvestment and profit repatriation, need to be taken into account.
FPI
Foreign portfolio investment (FPI) is another source of capital. FPI invests in listed shares and bonds, thereby widening the investor base and improving market liquidity. But it can reverse rapidly when global interest rates rise, or investors become risk-averse. The Economic Survey 2025-26 noted that portfolio flows became volatile in the second half of 2024 because of global monetary and geopolitical developments.
ECBs
Businesses can also raise capital through External Commercial Borrowings, or ECBs. These include loans from foreign banks or shareholders, and bonds issued overseas. Their lower headline interest rate may be deceptive, as it ignores factors like currency depreciation and hedging costs.
For instance, a $100 million loan is worth 800 crore rupees when the exchange rate is 80 rupees to the dollar but 900 crore rupees when the rate is 90 rupee. Hedging limits this risk but raises the effective cost. ECBs make the most sense for companies with foreign-currency earnings or projects that can generate enough return to cover the currency and refinancing risks.
FCNR(B) and OFCBs
In addition to ECBs, FCNR(B) deposits and OFCBs are other channels that can bring foreign currency into India quickly. FCNR(B) is foreign-currency fixed deposits made by NRIs with Indian banks, while OFCBs are foreign-currency loans raised overseas by Indian banks.
Under the RBI’s US dollar-rupee forex swap facility, banks gave the dollars to the RBI and swapped them for rupees, with an agreement to reverse the transaction later. As mentioned earlier, the RBI attracted $143.596 billion in foreign currency inflows till September 18. Of this, FCNR(B) deposits accounted for $132.98 billion, OFCBs for $5.32 billion, and ECBs for $5.296 billion. These inflows also helped increase India’s foreign-exchange reserves.
The facility supported the rupee and added liquidity when other foreign investment was weak. But this is not permanent capital. The deposits and loans must eventually be repaid, and the RBI must return dollars when the swaps mature. Such windows can provide temporary stability, but they cannot replace long-term FDI, deep domestic capital markets, strong exports and lasting investor confidence.
How government accesses foreign capital
The Union government finances most of its fiscal deficit through rupee-denominated securities sold primarily to domestic investors. Unlike dollar-denominated sovereign loans, this protects the government from the direct increase in debt due to rupee depreciations or international market volatility.
The government can nevertheless receive loans from institutions such as the World Bank and the Asian Development Bank, as well as from foreign development agencies. Such financing is generally directed towards infrastructure, health, urban development, and energy projects. Foreign investors can also buy Indian government securities. Since these bonds are denominated in rupees, the government owes rupees and the investor generally carries the exchange-rate risk.
India’s inclusion in global bond indices has expanded this channel of foreign investment. Eligible government securities entered JPMorgan’s emerging-market bond index from June 2024. Index inclusion can broaden the investor base and potentially lower borrowing costs. But it also creates a transmission channel for global shocks. For example, an index-tracking fund may sell Indian bonds because emerging-market allocations are being reduced globally, not because India’s fundamentals have deteriorated.
India’s external debt stood at $762.8 billion at the end of March 2026, an increase of $26.3 billion over the year. But this was not all sovereign debt: the general government accounted for 22 per cent, while companies, banks and other financial institutions accounted for most of the remainder, according to the RBI.
What role RBI plays
The RBI does not raise foreign capital as a company or the government does. Its job is to manage the impact of foreign-currency inflows and outflows. Suppose a foreign company brings $1 billion into India and converts it into rupees. If importers need those dollars, the market can absorb them. However, if there is an excess supply of dollars and excess demand for rupees, the RBI may buy some of those excess dollars to prevent a sharp rise in the rupee.
The RBI pays rupees for the dollars. Its foreign currency assets therefore rise, but rupee liabilities also increase. Foreign-exchange reserves are therefore purchased assets, not profit or free money available to the government.
The process can work in reverse when foreign capital flows out. The RBI can sell dollars to limit disruptive currency movements. Reserves act as insurance against sudden outflows, import shocks, and external repayments. They do not undo India’s foreign liabilities: some of these dollars may be needed when investors and lenders take their money back.
Sources of income for RBI
The RBI earns interest on foreign securities and domestic government bonds. It also earns seigniorage: currency notes pay no interest, while the assets held against them generate income. A weaker rupee or higher gold price can increase the reported value of RBI assets. But these are unrealised gains and can reverse. They cannot safely be treated as ordinary profit.
The RBI’s Economic Capital Framework decides how much income should be retained as protection before the remaining surplus is transferred to the government. Its Contingency Risk Buffer covers monetary and financial-stability risks, credit losses and operational failures.
The Bimal Jalan Committee’s framework originally set this buffer at 5.5-6.5% of the RBI’s balance sheet. The 2025 review widened the range to 4.5-7.5%. The trade-off is clear: a smaller buffer gives the government a larger transfer in the short-term, while a larger buffer gives the RBI more strength to respond to future shocks. Surplus transfers should therefore follow a transparent assessment of risk, not the government’s immediate fiscal needs.
How much capital should a central bank hold?
There is no universal international ratio for how much capital a central bank should hold. Central banks have different mandates, assets and arrangements with their governments. For example, when higher interest costs pushed the US Federal Reserve into losses, it stopped transfers to the Treasury and recorded the shortfall as a deferred asset to be covered by future profits.
The European Central Bank (ECB) recorded a €7.9 billion loss in 2024, which it carried forward to be offset against future earnings. In the case of the UK, the British Treasury receives the gains and covers the losses on the Bank of England’s main quantitative-easing facility. The Swiss National Bank, on the other hand, uses reserves to absorb large fluctuations and smooth payments to the government.
A central bank can continue operating during temporary losses because it issues currency. But prolonged financial weakness can undermine its credibility and make it dependent on government support. Capital matters because it preserves the central bank’s independence and its ability to act decisively during a crisis.
What India needs to prioritise
India should aim for better foreign capital than just more of it. As capital increasingly moves towards semiconductors, data centers, critical minerals, and green energy, economic policy must consider not only the amount of money entering the country but also national security, sanctions and export controls.
At the same time, India needs to deepen its domestic bond, pension and insurance markets. The strong domestic financing will help ensure that investment does not stop when capital retreats. The RBI also needs to maintain adequate foreign-exchange reserves and capital buffers to manage external shocks and sudden outflows without compromising monetary stability.
The goal should not be to attract every available dollar. India should ask what the money will build, how long it will stay, what liability it creates, and who carries the risk. Foreign capital should strengthen India’s productive capacity, not make its growth excessively dependent on decisions taken abroad.
Post read questions
1. Why is gross FDI inflow an inadequate measure of the net contribution of foreign capital to an economy? Explain the role of foreign-exchange reserves in protecting an emerging economy from sudden capital outflows.
2. What is the significance of rupee-denominated government securities for India’s external vulnerability?
3. External debt is not the same as sovereign external debt. Explain the distinction and discuss its significance for assessing India’s external-sector vulnerability.
4. India’s external financing strategy faces a three-way challenge: attracting capital, managing currency risk and preserving macroeconomic stability. Discuss.
5. The ultimate test of foreign capital is not how much enters the country, but what risks and productive capacity it creates. Critically examine.
(Pushpendra Singh is an Assistant Professor of Economics at Somaiya Vidyavihar University, Mumbai, and Archana Singh is an Assistant Professor of Gender and Economics at the International Institute for Population Sciences, Mumbai.)
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