#347 Clawing Back

Economic Rearguard Action, Ten Years of Bihar's Prohibition, and Making Sense of the Many Critical Mineral Frameworks

India Policy Watch #1: Dollar Dreams

Insights on current policy issues in India

—RSJ

The MPC (Monetary Policy Committee) meeting this week wasn’t expected to be business as usual. There’s a degree of doom and gloom about the Indian economy that needed to be addressed and, possibly, acknowledged. The full impact of the West Asia supply shock is yet to be passed on, and the foreign institutional capital continues to flow out. I was expecting some straight talk about the state of the economy and specific measures on drawing foreign capital in. The governor delivered on both in some measure.

The Reserve Bank of India left the repo rate unchanged at 5.25 per cent and retained its neutral stance. There was little surprise in that decision. Growth remains reasonably resilient so far despite oil supply constraints and recent price hikes. Inflation has begun to inch above comfort levels, and the global environment remains uncertain enough to justify caution. The more consequential aspect of the policy was about foreign capital, as expected. The RBI used this meeting to launch a broad-based effort to attract foreign capital at a time when the India story has very few buyers and the global competition for capital is becoming more intense.

The growth and inflation projections had to be revised. There was no way to avoid that reality. The RBI lowered its FY27 growth estimate from 6.9 per cent to 6.6 per cent while raising its inflation forecast from 4.6 per cent to 5.1 per cent. The growth downgrade is concentrated in the second half of the year, which means the government plans to cushion the impact of the oil price hike for a few more months.

The inflation revision reflects concerns around energy prices, supply chain disruptions and weather-related risks (a below-average monsoon is most likely). The central bank, therefore, finds itself in an uncomfortable position. Growth risks have increased, but so have inflation risks, along with the stress on the Rupee. The room for any monetary easing has therefore narrowed considerably. Most analysts have factored in at least a 50-75 bps rate increase for the rest of the year.

Once that plain speaking was done, the governor moved to the pressing point on attracting foreign capital. The package announced by the RBI spans multiple channels of bringing in foreign capital.

Banks have been given incentives to raise FCNR(B) deposits by allowing the RBI to bear the full hedging costs on fresh three-to-five-year deposits mobilised until September 2026. The economics of FCNR(B) deposits have become considerably more attractive. Basically, RBI is insuring the currency risk for the banking system in drawing in foreign deposits at domestic rates. This is more than what Banks were expecting, and the past experience (during Governor Rajan’s tenure) on this has been positive. Banks no longer need to absorb hedging costs and reserve requirements on these deposits. This allows them to offer significantly higher rates to non-resident depositors. With US Treasury yields around 4 per cent and Indian banks potentially offering materially higher returns (7+ per cent), the proposition becomes compelling for many overseas Indians.

Also, public sector undertakings (PSUs) have been offered concessional swap facilities to encourage external commercial borrowings. This window could see good utilisation. External commercial borrowing by Indian companies slowed in FY26 as global funding conditions tightened. The RBI’s swap support improves borrowing economics and could revive overseas issuance by public sector borrowers and highly rated corporates. Again, the RBI is taking the hit on currency risk on behalf of the PSUs to encourage them to borrow in Dollars.

The investment universe available to foreign investors in government securities has been expanded. Restrictions on overseas participation in domestic equity markets have been eased. Export proceeds will once again need to be brought back within nine months instead of fifteen. Taken together, these represent a coordinated attempt to improve India’s balance of payments position and augment dollar liquidity.

The comparison with 2013 is useful. During the taper tantrum, the RBI’s FCNR(B) mobilisation scheme brought in over $30 billion and helped stabilise financial markets at a time of severe stress. The market is once again discussing inflow numbers in the range of $40-50 billion.

Yet the durability of these inflows will need to be seen. The FCNR(B) experience of 2013 is remembered largely because of its success in attracting dollars. Less attention is paid to the fact that these deposits were fundamentally rate-sensitive liabilities. They entered because the incentives were attractive and remained as long as those incentives continued to make sense. The same observation applies today. Such flows help address liquidity shortages, support the currency and reduce funding pressures in the banking system. They do not alter the structural drivers of external financing.

The bond market reforms are potentially more significant because they address a longer-standing issue.

For years, India sought deeper participation by foreign investors in its government bond market while retaining tax and regulatory features that reduced the attractiveness of Indian debt relative to competing markets. The decision by the government to exempt eligible foreign investors from taxes on interest income and capital gains from certain government securities, combined with the RBI’s decision to expand the Fully Accessible Route, removes some of the frequently cited impediments.

Foreign ownership of Indian government securities remains modest relative to the size of the market. The available investment headroom remains substantial. Inclusion in major global bond indices has already begun drawing passive flows into India. The latest reforms strengthen the case for broader participation and may improve India’s prospects for inclusion in additional benchmark indices where operational and tax concerns have previously acted as constraints.

At the same time, it is important not to confuse easier access with guaranteed inflows.

Foreign investors allocate capital on the basis of expected returns after adjusting for currency risk. India offers attractive nominal yields, but the currency remains central to the investment decision. A bond yielding 7 per cent becomes significantly less attractive if investors expect persistent depreciation of the rupee. Tax exemptions and expanded market access improve the equation, but they do not eliminate this consideration.

The central bank appears to be doing its bit in seeking a virtuous cycle in which stronger inflows support the currency, greater currency stability encourages additional investment and improved liquidity conditions lower funding pressures across the financial system. But that may not be enough unless the government does its bit on improving business environment for foreign investments (not doing stupid things like retrospective taxation will help), reducing market concentration in key sectors, allaying fears of India being an AI laggard by investing aggressively in the upstream AI chain and making its large domestic market count at a strategic level.

The immediate domestic benefits of the MPC steps are easy to identify. Banks have struggled to mobilise deposits at the same pace as credit growth. Additional foreign currency inflows can ease these constraints, support loan growth and reduce pressure on wholesale funding markets. Yields on certificates of deposit, commercial paper and government securities may benefit from improved liquidity conditions. The decline in intermediate bond yields immediately after the policy reflects these expectations.

Whether these benefits persist depends less on domestic policy and more on global developments.

The RBI’s revised inflation forecast assumes crude oil at around $95 per barrel. Any prolonged disruption in global energy markets would place this assumption under pressure. If the Strait of Hormuz remains disrupted for an extended period, higher commodity prices could feed into inflation globally and domestically. The central bank’s own projections show inflation approaching 6 per cent during the third quarter of FY27.

That is why the market continues to price in an almost 75 bps probability of a rate hike in the coming months. The policy statement itself reflected a shift. Earlier communications emphasised the provision of “sufficient” liquidity. The latest statement refers to “appropriate” liquidity. The change is small but not insignificant. The RBI has bought itself some time. It has strengthened the incentives for foreign capital to enter India and improved the attractiveness of several financing channels. These measures are likely to generate good inflows and provide support to both the banking system and the currency.

The larger test will come over the next six to twelve months. The success of this package should be measured beyond the initial surge of dollars into the system. It will be measured by whether India is able to attract sustained capital despite a world of higher interest rates, greater geopolitical uncertainty and increasing competition for global savings. That remains a more persistent challenge of selling the India story.

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India Policy Watch #2: Tippling Over

Insights on current policy issues in India

—Pranay Kotasthane

It’s been ten years of Bihar’s prohibition. There seems to be no obvious movement towards reversing it, despite a change in the political guard. Later next week, the Bihar government is holding another entrance exam for the post of Bihar Police Prohibition Constable. It’s surreal that a state with poor law and order has been diverting its limited financial and intellectual state capacity towards catching tipplers for a decade now.

We had written about this tragedy way back in 2022 in these pages. As expected, addiction has only moved to other dangerous substances. Himanshu Harsh, in an Indian Express explainer last week, writes how cough syrup has become the new hooch in Bihar:

Since Bihar enforced alcohol prohibition in 2016, codeine cough syrups have emerged as an increasingly popular alternative to alcoholic beverages…

Following the ban, many former alcohol users have turned to other, easily accessible substances like cannabis, heroin, and most notably, codeine syrups. In Patna and across rural Bihar, users can often obtain these syrups through the black market or from pharmacies with inadequate oversight.

Codeine syrups are particularly attractive due to their affordability and powerful sedative effects. Their easy availability and relatively low cost — typically INR 100-200 per bottle — have contributed to their increasing popularity as an alcohol substitute. This issue is particularly alarming in Bihar, where the substance abuse crisis has shifted from alcohol to opioids, creating new challenges for law enforcement and public health authorities. [Indian Express, May 30]

So now the Prohibition Constables will also be chasing cough syrups and raiding pharmacies, thereby increasing the surface area of corruption. And we haven’t even discussed the second-order impact on the patients who couldn’t get these cough syrups because of their newfound popularity. It’s striking how predictable and yet inevitable the fallouts of this policy are, and yet there seems to be no change in the government’s stance.

P.S.: During the Bombay Prohibition Act, people turned towards high-alcohol-content tinctures, eyedrops, and eardrops. Sixty years later, all we can say is that people have slightly better alternatives on offer now.

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Matsyanyaaya: Five Ideas for Cooperation on Critical Minerals

Big fish eating small fish = Foreign Policy in action

—Shobhankita Reddy and Pranay Kotasthane

(An edited version of this article first appeared in The Hindustan Times on June 5, 2026)

On 26th May, India and the US signed a bilateral Critical Minerals framework; the same day, the Quad unveiled a $20 billion initiative spanning mining, processing and recycling. These join a growing list of recent US-India partnerships, including FORGE, Pax Silica, the bilateral TRUST, and the Strategic Mineral Recovery Initiative (SMRI). While the details of the India-US framework are not publicly available, the Quad countries jointly released a statement outlining key areas of cooperation.

The US is a minor direct consumer - accounting for less than 5% of global demand - for minerals such as cobalt, nickel and rare earths. Its imports of components made using these elements are orders of magnitude higher. India, too, is import-dependent in this sector. Its vast, rare-earth reserves remain unexplored, and its processing capabilities are underdeveloped. The instinct to respond through international partnerships in a sector acutely prone to Beijing’s economic coercion is sound and pragmatic.

However, many of these partnerships are yet to translate into assured mineral flows, technology transfers, or capacity building for processing and downstream manufacturing. These tangible outcomes will require work on five fronts.

First, China’s dominance in rare earths is rooted in subsidy-linked overcapacity that has driven out efficient producers elsewhere. Overcapacity is a structural feature of China’s investment-led model. Establishing alternative mine-to-magnet supply chains would require partner countries to combat this artificial price suppression through aggregate demand, long-term offtake guarantees, and coordinated price-risk mechanisms. That’s where the Quad initiative’s intent to mobilise ‘guarantees, loans, equity participation, insurance, subsidies, and offtake or other commercial arrangements’ holds promise.

Second, not all critical minerals are equally critical and require different approaches to ensure supply resilience. Rare earth elements, vanadium and antimony, for instance, are used in small quantities and for highly specialised applications. Their low demand, combined with high-criticality use cases, makes China’s dominance an effective lever in the short term. Export controls on these items disproportionately hurt other countries more than they hurt China itself. Partner countries should work together to stockpile these minerals, as their alternative supply-building is notoriously unviable in the immediate term. In contrast, minerals with a wide range of commercial applications and that are required in larger quantities - such as copper - are harder to stockpile and need a steady supply from diversified sources to offset any short-term shocks.

The US’s $12 billion Project Vault initiative is aimed at stockpiling for US firms but is bound to be inefficient. It does not differentiate between mineral categories and is financially inadequate for major minerals. Further, it risks distorting the prices of minor minerals already needed in small quantities. Expanding the initiative to more countries will make stockpiling economically viable by increasing both the available capital pool and overall demand.

Third, stockpiling without value-added manufacturing will not achieve derisking. China’s monopoly lies in the processing stage of the value chain. Opening new mines elsewhere will not sufficiently dent this without a proportionate scale-up of refining and magnet manufacturing capacity outside China. This would require joint research collaborations and partnerships that can help India move beyond being a consumer of final goods or an exporter of unprocessed ore.

For instance, India exports manganese ore in its raw form, the value of which would increase by three to ten times if it could refine it domestically to produce ferromanganese or manganese steel.

Additionally, breaking China’s chokehold on this sector would require not only investments in substitutes, such as using iron or manganese in place of cobalt for batteries, but also innovations and design improvements that make magnets rare-earth-free. While the current frameworks emphasise tech sharing, these efforts must be further strengthened.

Fourth, critical minerals differ from oil in that they can be recovered from their sources and reused. Recycling is often an underappreciated facet of mineral security, even though it enables a closed, insular loop from already available, friendshored products. Today, due to a poorly scaled collection network in most consumer economies and a genuinely limited amount of available feedstock, recycling can meet only a small percentage of overall demand. This necessitates pooling electronic waste and establishing joint recycling facilities to scale production as more products reach end-of-life over the next few decades. It is thus encouraging that the Quad critical minerals initiative seeks to ‘promote innovation in critical minerals recovery from, and recycling of, e-waste and scrap materials among Quad partners.’

However, as seen in the case of lithium over the past few years, unusually low prices of Chinese primary production can disincentivise recycling - less than 3% of lithium’s global demand currently comes from recycling. Procurement policies with guaranteed price floors between partner countries would be essential for recycling facilities to survive any price crashes in commodity markets, and would be critical.

Finally, the framework should extend to resource-rich countries in Africa and Latin America, where both the US and India have signed several agreements. Combating China’s entrenched presence in these countries and its ability to commit long-term capital while nimbly navigating political risks requires coordination and blended-finance mechanisms that provide a political backstop for private enterprises. Ownership of these existing mines is particularly important because starting a new mine typically takes an average of 16 years from discovery to production, with anecdotal data suggesting even longer timelines in the US and India.

The many frameworks on critical minerals are vital for managing the inevitable ‘China Shock’, in which low-priced minerals exported from China will make projects elsewhere uncompetitive. Tackling this scenario requires on-ground coordination between companies in like-minded countries across the entire critical mineral supply chain.

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HomeWork

Reading and listening recommendations on public policy matters

1. [Podcast] This BigIdea conversation between Pratap B Mehta and Shruti Rajagopalan is a fantastic listen. The point that caste has regrettably become the lazy explanation for everything is important to internalise. Several other gems in this episode.

2. [Article] Helpful post by Brian Albrecht, explaining why the compute tax is a bad idea. I am expecting this idea to reach India soon. And the latest Oxfam Report on Inequality or something similar will propose this. Soon, everyone will start taking this idea seriously, even though it’s a terrible one.

3. [Policy Brief] Anupam Manur wrote three weeks ago that the capital gains tax for foreign portfolio investors should be abolished to stem the outflow of capital. The government’s move last week, exempting taxes on gains accruing to foreign investors from certain government securities, points in the same direction. There are several other useful recommendations in this policy brief.

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