India’s external sector is under scrutiny amid a widening divergence between volatile capital flows and steadily strengthening balance-sheet fundamentals. Heightened global uncertainty has softened capital inflows and intermittently pressured the currency. In our view, however, external accounts continue to display resilience. While cyclical noise has intensified, there are no signals of deeper macro vulnerability.
India has historically run a current account deficit (CAD), consistent with a growth model that prioritises investment beyond domestic savings. Over the past decade, however, both the size and composition of the deficit have improved materially. During FY16-25, the CAD averaged about 1% of GDP, less than half the average of the preceding decade.
Invisible Shield
This benign trend reflects structural shifts rather than cyclical tailwinds. Merchandise exports have remained largely steady, as reflected in India’s plateauing share of global goods exports. Instead, three secular drivers have underpinned improvement: (i) favourable terms of trade led by declining oil intensity, which has fallen from 0.18 in the early 2000s to about 0.12 currently amid relatively stable global oil prices; (ii) a structural upswing in services exports, supported by the offshoring boom and the rise of global capability centres that increasingly extend beyond traditional software into business services, with services exports’ global market share rising by around 130 basis points (bps) since 2019; and (iii) robust remittances, now tracking at about 3.2% of GDP, with India emerging as the world’s leading recipient, aided by a shift towards higher-skilled migration to advanced economies rather than Gulf-centric flows.
The resilience of the “invisibles” component has acted as a stabilising force, offsetting weakness in goods exports amid volatile global trade conditions. That said, recent geopolitical developments pose risks of a temporary widening in the CAD via higher oil and non-oil commodity prices, depending on the duration of disruptions. A 10% increase in oil prices can widen the CAD by roughly 30 bps of GDP.
In contrast to the improving current account, the capital account has weakened over time. Historically, it ran a surplus of around 4% of GDP during FY06-15, but this fell to about 2.2% of GDP in FY16-25. Cyclically, capital flows have become increasingly fragile. On a four-quarter trailing basis, the capital account has recorded net outflows and remains close to all-time lows as of QE December 2025.
Capital Account Turbulence
Since January 2024, foreign institutional investor (FII) flows have oscillated between muted inflows and outright outflows. Tighter global financial conditions, a stronger US dollar, and elevated uncertainty have weighed on sentiment. In 2025, cumulative FII outflows amounted to $11.3 billion. Following the announcement of the India-US trade deal, sentiment has improved modestly, with inflows of around $3.6 billion recorded in February 2026.
Net foreign direct investment (FDI) has also remained constrained, despite resilient gross inflows. In 2025, gross FDI rose 10% year-on-year to $90.8 billion. However, net inflows were subdued at $4.4 billion, as repatriation exceeded $50 billion and outward FDI accelerated, surging to $34.6 billion.
The interaction of the current and capital accounts is reflected in the balance of payments (BoP), which has typically remained in surplus. In FY25, the BoP slipped into a marginal deficit of about 0.2% of GDP, driven largely by capital outflows. We expect the BoP to remain in deficit in FY26 as well, given lacklustre flows, marking the first instance of two consecutive years of BoP deficits.
Despite turbulence on the flow side, fundamentals provide meaningful weight. The external balance sheet remains fortified, supported by substantial foreign-exchange reserves, comfortable import cover, and a manageable external debt profile. Official assessments suggest India performs well on debt sustainability metrics relative to peers. Fundamentals therefore remain strong enough to anchor stability, even as capital flows stay uneven.
The recent rupee weakness should be viewed through the combined lens of dollar strength driven by interest-rate differentials, volatile portfolio flows, and trade-related uncertainty. With the US trade deal now in place, downside risks appear limited. Relatively cheap valuation versus fundamentals, improving capital-flow prospects, and a better trade outlook should offer support. The RBI’s short forward position of over $60 billion is likely to cap sharp appreciation, favouring measured gains instead. On a real effective exchange rate basis, the rupee remains undervalued, supporting export competitiveness.
India’s external narrative remains anchored in steady fundamentals that have helped offset volatility in global capital flows. Near-term risks stem from the duration of geopolitical tensions and their potential impact via higher commodity prices, weaker export growth, and pressure on remittances. Over the medium term, rapid advances in AI pose emerging risks that warrant monitoring. Policy efforts to enhance competitiveness—particularly through strengthening domestic manufacturing and boosting merchandise exports—will be critical to sustaining growth and reducing external vulnerabilities. On the capital account, favourable growth differentials and deeper integration into global bond indices should, over time, support a more constructive flow environment.