Knowledge Nugget: What are FCNR (B) deposits and swap scheme?

Take a look at the essential concepts, terms, quotes, or phenomena every day and brush up your knowledge. Here’s your knowledge nugget on the Foreign Currency Non-Resident (Bank), or FCNR(B) deposits for today.

The Reserve Bank of India (RBI) on 23rd June said Indian banks, including their overseas branches, are permitted to extend loans to non-resident account holders or even issue Standby Letters of Credit (SBLC) in favour of overseas lenders against FCNR(B) deposits mobilised under the new swap facility.

1. RBI, through its circular dated 8 June 2026, introduced a US Dollar-Rupee forex swap facility for fresh FCNR(B) deposits mobilised for three- to five-year terms until September 2026. It permitted them to swap these deposits with the RBI at a concessional rate, effectively covering the entire hedging cost.

The cost of hedging refers to the cost of protecting an investment against adverse market risks such as currency fluctuations.

2. By absorbing the hedging burden, the RBI has made FCNR(B) deposits a more attractive source of overseas funding for lenders. Experts believe the steps announced may attract an additional $50 billion to $70 billion in foreign capital into Indian markets, provided the banks offer the right interest rates after considering the hedging sops.

3. This FCNR (B) swap scheme is revived after nearly 13 years with the vision that it will do much of the heavy lifting when it comes to bringing in foreign inflows. The facility is a plain buy/sell foreign exchange swap from the RBI side covering only the principal amount of the deposits and not the interest component.

4. The FCNR(B) swap scheme is even more potent this time around. In 2013, the RBI provided a 3.5% subsidy to banks. Now, it will fully bear the exchange rate risk on new three- to five-year deposits mobilised until September 30.

5. The latest FCNR(B) swap facility, whose guidelines were announced by the RBI on June 8, comes into effect immediately and will remain open up to October 16 for deposits mobilised until September 30. Banks would be free to price these deposits as per their internal policy, but within the overall ceiling as per the extant guidelines issued by the RBI.

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Infographics by NotebookLM

6. The RBI says a bank can avail of the swap facility only once in a week. During any week, the maximum US dollars that a bank would be eligible to swap with RBI would be equal to all eligible FCNR(B) deposits mobilised in equivalent US dollar terms during the preceding week(s) for which the facility has not been availed earlier.

7. Banks can sell US dollars in multiples of $1 million to RBI and simultaneously agree to buy the same amount of US dollars at the end of the swap period. In the first leg of the transaction, the bank will sell US dollars to the RBI at the FBIL Reference Rate.

FBIL refers to Financial Benchmarks India Private Limited, which publishes multiple benchmark interest rates and foreign exchange reference rates daily for the Indian financial market.

8. Under the framework, banks are also exempted from maintaining the cash reserve ratio (CRR) and statutory liquidity ratio (SLR).

CRR is the minimum percentage of a bank’s total deposits required to be maintained as liquid cash, SLR refers to the minimum percentage of deposits that banks must maintain in highly liquid assets (such as cash, gold, or government-approved securities) before they can lend money to customers.

What are the FCNR (B) deposits?

1. FCNR (B) are fixed-term deposits designed for Non-Resident Indians, Persons of Indian Origin (PIO), and Overseas Citizens of India (OCI). Such deposits allow account holders to park their earnings abroad in freely convertible foreign currencies without having to convert them into rupees.

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2. These deposits allow overseas Indians to maintain their savings in designated foreign currencies such as the US dollar, pound sterling, euro, Japanese yen, Australian dollar, and Canadian dollar, rather than converting their funds into Indian rupees.

3. Interest earned on FCNR(B) deposits is exempt from income tax in India as long as the depositor qualifies as a non-resident under Indian tax laws. Under the current framework, banks can offer rates linked to internationally accepted benchmark rates.

4. According to the RBI, the FCNR(B) scheme was introduced with effect from May 15, 1993, to replace the then prevailing FCNR(A) scheme introduced in 1975, where the foreign exchange risk was borne by the RBI and subsequently by the Indian government. The FCNR(A) scheme was withdrawn in August, 1994 in view of its implications for the central bank’s balance sheet and quasi-fiscal costs to the Government.

BEYOND THE NUGGET: Withholding Tax

India's Withholding Tax on Foreign Investors — Explained

The Policy Move What is WHT? World vs India India's WHT History

$38B

Forex reserves lost since March 2025

20%

Current withholding tax rate

5%

Proposed concessional rate

WHY NOW

West Asia conflict triggers forex alarm

Capital outflows driven by the West Asia conflict and a surge in crude oil prices have eroded India's foreign exchange reserves by nearly $38 billion since March 2025. The government is now reportedly considering slashing the withholding tax on foreign bond investments from 20% back to the earlier concessional 5% rate to revive overseas inflows and stabilise reserves.

BROADER RESPONSE

WHT cut part of a wider forex defence

The government has already proposed cuts in expenditure, restrictions on foreign travel, curbs on gold imports, and limits on other non-essential spending to manage the external account. A WHT reduction would complement these outflow-curbing measures by actively attracting foreign capital back in.

FPI DEBT FLOWS

Flows have already reversed in FY27

After $2.8 billion in FPI inflows into debt in FY26, the category has seen outflows of $613 million in FY27 so far across the general limit, VRR and FAR windows. FPI investment in dated government securities had jumped 43.2% to $43.9 billion by end-March 2025 — gains that the outflow cycle now threatens to unwind.

DEFINITION

Tax collected before money leaves India

Withholding tax (WHT) is a tax deducted at the source of income — similar to TDS. Instead of waiting for a foreign investor to pay taxes at year-end, the government requires the Indian payer to deduct a portion of the income before remitting it abroad. The deducted amount is deposited directly with the government.

How it affects foreign investors

↓

Compresses post-tax yields

WHT is deducted before interest or dividend income reaches the investor, directly reducing effective returns and weakening long-term compounding power.

⏳

Creates short-term liquidity constraints

For large global investors, deductions lock up funds until tax credits or refunds are processed under Double Taxation Avoidance Agreements (DTAAs).

⚖

Increases compliance burden

FPIs face significant administrative friction in claiming DTAA relief. Higher WHT raises transaction costs, lowers risk-adjusted returns, and creates regulatory friction.

★

Applies to all passive income types

WHT covers interest on government securities and bonds, dividends, royalties, and fees for technical services — wherever income is earned by a foreign entity from India.

GLOBAL CONTEXT

India among the higher-tax jurisdictions for bond investors

Most countries tax passive income from foreign investors, but rates and exemptions vary widely. At 20%, India sits above most peer emerging markets. The proposed cut to 5% would make it competitive with China and well below Western markets.

Withholding tax on bond interest — country comparison

🇺🇸 United States

30%

🇩🇪 Germany

26.4%

🇫🇷 France

25%

🇮🇳 India (current)

20%

🇨🇳 China

10%

🇮🇳 India (proposed)

5%

🇭🇰 Hong Kong

0%

🇸🇬 Singapore

0%

"The inclusion [in Global Agg and FTSE WBGI] could imply $45–50 billion of inflows over two years... Several major nations do not tax bond investments, and even those that do, like China, gave a special dispensation to investors that entered after index inclusion."

— Prateek Ancha, Senior Vice President, Axis Bank

POLICY EVOLUTION

Five decades of India's withholding tax journey

India's withholding tax regime has evolved significantly since the 1970s — from prohibitively high rates designed to protect domestic industry, to concessional rates meant to attract foreign capital and global bond index inclusion. The current 20% rate is a reversion, not a new high.

1976

WHT on royalties fixed at 40%. Fees for Technical Services (FTS) attracted a 20% levy — among the highest rates India would impose on foreign income.

1986 – 2005

Both royalties and FTS rates cut to 10%. The reductions aimed to lower technology acquisition costs for Indian companies and encourage foreign collaboration over a sustained 19-year reform period.

Section 194LD Introduced

India introduced a concessional 5% WHT rate on interest earned by FPIs from investments in government securities and certain rupee-denominated bonds under Section 194LD of the Income Tax Act.

July 2023

Concessional 5% regime expired. The Section 194LD facility was not renewed. WHT for many FPIs effectively reverted to ~20%, making India one of the relatively higher-tax jurisdictions for global bond investors. Analysts say this reduced India's attractiveness at a time it was also seeking greater global bond index inclusion.

FY26

India included in JPMorgan Government Bond Index-EM. FPI investment in dated government securities jumped 43.2% to $43.9 billion by end-March 2025. But index peers Global Agg and FTSE WBGI still seek clarity or exemption on the tax.

May 2026 — Current

Government reportedly weighing a return to 5% WHT. With $38 billion in forex reserves eroded since March and FPI debt outflows of $613 million in FY27, the case for reviving the concessional rate — and unlocking a potential $45–50 billion from further index inclusions — is mounting.

Sources: The Indian Express · Reserve Bank of India · Axis Bank Research (Prateek Ancha) · DBS Bank (Radhika Rao) · Income Tax Act, Section 194LD

1. Amid pressure to attract foreign funds and also stabilise the rupee, the Centre has also scrapped the capital gains tax, both long-term and short-term, on investment by Foreign Institutional Investors (FIIs) in government bonds as well as the withholding tax they must pay on their interest income from these debt instruments.

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2. Before scrapping, non-residents pay a withholding tax of about 20% on the interest they get on the government bonds they hold — one of the highest in the world — after a concessional rate of 5% ended in 2023.

3. A high withholding tax is seen as a major deterrent for foreign capital inflows at a time when India is grappling with rising external pressures, including a sharp surge in crude oil prices.

4. Withholding tax, or WHT, is a tax collected at the source of income. Instead of waiting for an investor or foreign company to pay taxes at the end of the financial year, the government requires the payer to deduct a portion of the income before it is remitted to the recipient.

5. The deducted amount is then directly deposited with the government. In simple terms, whenever income is earned — whether through employment, investments, royalties or other sources — the government ensures tax collection in advance through withholding tax.

Post Read Question

Consider the following statements:

1. Higher withholding tax leads to higher foreign capital inflow.

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2. FCNR (B) are demand deposits designed for NRI, PIO, and OCI.

Which of the statements given above is/are correct?

(a) Only 1

(b) Only 2

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer Key

(d)

(Sources: Why RBI is returning to a ‘terrible’ idea to boost foreign inflows, FCNR(B) deposits: Why higher interest rates may be needed to bring in NRI dollars, India banks can lend against FCNR(B) deposits, says RBI)

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