Why in the news

The rupee’s recent fall is not driven by a widening current account deficit, as traditionally believed, but by an unprecedented decline in net foreign capital inflows, which have turned sharply negative for the first time in years. During April-September 2025, India saw a net outflow of $7.6 billion, a stark reversal from the $25.3 billion net inflow in the same period of 2024. This contrast signals a structural shift where India’s strong services surplus can no longer offset the sharp rise in the goods deficit alongside shrinking foreign investments, making this a serious macroeconomic turning point

Introduction

India’s external sector is undergoing a structural change where the merchandise trade deficit continues to expand, the invisibles surplus remains strong, but the capital account, especially foreign investment inflows, has weakened significantly. As a result, the rupee’s pressure today arises primarily from capital account weakness, not the current account alone, reshaping India’s macroeconomic stability narrative.

Why is India’s current account under persistent pressure?

1. Widening Merchandise Trade Deficit: India’s goods trade deficit more than doubled from $91.5 bn (2007-08) to $191 bn (2022-23) and is expected to cross $300 bn in 2024-25.
2. Strong but Insufficient Invisibles Surplus: Remittances, software exports and professional services push invisibles surplus to record highs, yet not enough to neutralise the merchandise gap.
3. Sticky Imports & Slow Exports: Energy, electronics, and gold imports remain elevated; global demand conditions weaken export earnings.

How have invisibles cushioned the external sector so far?

1. Record Remittances: Private transfers and remittances remain robust—India continues as a top global recipient.
2. Soaring Software & IT Services Surplus: Services exports support the current account and contribute to India’s “invisible strength.”
3. Investment Income Outflows: Rising payments on interest/dividends reduce the net benefit of the invisibles surplus.

What explains India’s capital account problem today?

1. Sharp Fall in Net Capital Inflows: April-September 2025 saw $7.6 bn net outflow vs $25.3 bn inflow in 2024, the biggest recent reversal.
2. Weakening Foreign Investment: FDI inflows into new factories, infrastructure, and physical assets have dropped sharply.
   1. FDI: $43 bn (2020-21), $22 bn (2022-23),  $8 bn (2023-24) till December.
3. Portfolio Flows Turning Volatile: FY23-24 saw equity outflows of $23 bn, reversing the earlier inflow phase.
4. India’s Relative Growth Advantage Narrowing: High global interest rates and stronger USD attract capital away.

Why does the rupee weaken despite manageable CAD?

1. Capital Outflows Overpower CAD Position: Even a moderate CAD becomes hard to finance when capital inflows dry up.
2. Pressure from USD Shift: Rupee slid from ₹83.47 to ₹89.39 per USD within the year as yen, won, and yuan also weakened.
3. Financing Gap: CAD remains dependent on capital inflows, weak capital flows lead to excess demand for foreign currency.

What are the macroeconomic consequences of the capital account strain?

1. External Financing Stress: Lower FDI and portfolio inflows reduce India’s ability to fund domestic growth.
2. Exchange Rate Volatility: Persistent rupee pressure increases import costs, especially energy and intermediate goods.
3. Growth Impact: Rupee weakness raises inflationary pressures and complicates monetary policy management.
4. Policy Trade-offs: RBI must balance FX stability, inflation control, and capital flow management.

CONCLUSION

India’s external account stresses now stem less from trade imbalances and more from capital inflow shortages. A resilient services surplus continues to stabilise the CAD, but declining foreign investments, both FDI and portfolio, expose the currency to sharper volatility. Addressing this requires strengthening domestic manufacturing competitiveness, improving investment climate, and ensuring predictable macroeconomic policies that reclaim India’s attractiveness for global capital.

UPSC Relevance

[UPSC 2021] Do you agree that the Indian economy has recently experienced V-shaped recovery? Give reasons in support of your answer.

Linkage: Capital account inflows, forex stability, and investment revival are key determinants of macroeconomic recovery. The article’s data on shrinking capital inflows and rupee pressures directly challenge the sustainability of a V-shaped path.

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