Once again, only after India has stumbled into a mini foreign-exchange crisis, is the government contemplating reforms. According to news reports, New Delhi is preparing measures to support the rupee and finance a widening current-account deficit. These may include reducing long-term capital-gains tax (LTCG) on listed equities and government bonds and lowering withholding tax on interest income earned by foreign investors. To curb capital outflows, officials are also considering reducing the annual limit under the Liberalised Remittance Scheme (LRS) from the current US$250,000 per individual.
The need for such measures stems from the rupee’s sharp decline over the past year, due to a large current-account deficit, persistent foreign portfolio outflows from the stock market, poor foreign direct investment (FDI) inflows, negative net exports, and capital outflows through both the LRS and outward FDI. The result is alarming: for the first time, India is running deficits in its current as well as capital accounts. That is perhaps the least commented marker of the seriousness of the problem. So concerning has the situation become that prime minister Modi recently appealed to citizens to curb non-essential imports, such as gold purchases and overseas travel, in order to conserve foreign exchange.
India has long run a current-account deficit because it imports more than it exports. But this was usually an irritant rather than a crisis because the gap could be financed through capital inflows of various kinds, generating a surplus on the capital account. But now, thanks to a series of policy missteps, half-baked reforms and poor execution, India faces deficits on both fronts. The combined pressure on the rupee and foreign-exchange reserves is the principal reason the currency has fallen from ₹84 to ₹94 against the dollar in just one year—a depreciation of nearly 12%.
This crisis was neither sudden nor unforeseeable. The task of a serious State is to identify structural vulnerabilities and address them long before they become emergencies. India has always known that spikes in oil and gold prices expose the economy’s weaknesses. Reducing import dependence should, therefore, have been a strategic priority. Equally, India has long needed to strengthen export competitiveness and narrow its current-account deficit, if not eliminate it altogether. Yet, progress on both fronts has been poor. In the meantime, while the current account was supposedly being repaired, policymakers should have welcomed foreign capital to ensure a surplus on the capital account and support currency stability. Instead, they often took steps that discouraged it.
There is, moreover, a strong positive reason to attract foreign capital beyond stabilising the rupee. India simply does not generate enough domestic savings to sustain the growth rate that policy-makers aspire to, let alone achieve the ambition of joining the ranks of developed economies. Economic growth comes from four sources: private consumption, government expenditure, net exports and fixed investment. Private consumption already accounts for around 61% of GDP, leaving limited scope for further expansion. Net exports remain negative. So, growth ambitions depend overwhelmingly on sustained increases in productive fixed investment. Given the current composition of GDP, investment must contribute roughly 3.73 percentage points to annual growth. To achieve 8% growth, investment itself would need to expand by about 8.9% a year. Historically, whenever India has experienced periods of rapid growth, investment has been the decisive driving factor.
Investment, however, requires capital. India’s domestic savings rate is insufficient to fund the level of investment required. If savings remain at roughly 32.5% of GDP, the country would need foreign capital equivalent to around 2.1% of GDP annually to bridge the gap—approximately US$88bn a year. Yet, India is currently running a negative capital-account balance. Foreign capital encompasses FDI, portfolio investment, external commercial borrowings, deposits and other inflows. Of these, borrowings and deposits create liabilities, while portfolio investment is only semi-permanent and can reverse quickly if conditions deteriorate. It is FDI that policy-makers should actively court. Yet, net FDI in FY25-26 amounted to just US$7.7bn. Although that represented a modest recovery from the dismal US$1bn recorded in FY24-25, it was still dramatically below the US$27bn-US$28bn seen in FY22-23 and FY23-24—and nowhere near the roughly US$90bn required each year.
Attracting foreign capital was, after all, one of the principal reasons India liberalised its economy in the first place. Every major economic success story has been fuelled by foreign capital, attracted through deliberate policies and accorded strategic importance by the state. According to economic historians, among the many tasks of growth promotion, recruiting foreign investment stands out as a top priority that must be entrusted only to the most competent people. In East Asia, investment promotion is the job of elite agencies that are professionally equipped to woo investors as well as to coordinate investment policies for the entire economy. In Singapore, this is EDB (Economic Development Board), and in South Korea, the equivalent body is the KOTRA (Korea Trade-Investment Promotion Agency). But the importance of attracting long-term FDI to achieve 8% growth appears to have faded from view in India. At the same time, buoyed by claims of India’s emergence as an economic superpower, policy-makers moved to discourage portfolio flows, first by reintroducing capital-gains tax on listed equities in 2018 and then by raising the rate further in 2024.
FDI itself presents a mixed picture. Gross inflows remain substantial, but so do outflows, leaving India with insufficient net capital to finance growth much above 7%. A large part of these outflows reflects repatriation and disinvestment by foreign companies which amounted to US$54bn in FY25-26. Another component comes from Indian firms investing abroad through equity injections, loans and guarantees, which reached roughly US$30bn that year. This raises an obvious question. Why would a country that requires close to US$90bn in net foreign capital annually to create jobs, build productive capacity and sustain rapid growth, permit US$30bn of capital to flow abroad, thereby contributing to pressure on the rupee? That, however, is another story.
(This article first appeared in Business Standard newspaper)
When china exports they export as a country.
Indians export for themselves because the entire system is corrupt. So until you do not make money don't export.At every stage of export and after exports the whole system is corrupt. Hope this message reaches Modiji.
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Indians export for themselves because the entire system is corrupt. So until you do not make money don't export.At every stage of export and after exports the whole system is corrupt. Hope this message reaches Modiji.