We can’t rely on capital inflows for rupee stability anymore: India’s economic model needs to change

What explains this disconnect?

A careful examination reveals an uncomfortable truth: strong domestic fundamentals alone no longer guarantee external confidence.

Recall that India is possibly the only large developing Asian economy that has run a consistent trade deficit for decades. Unlike China, Japan, Korea or most Asean peers, India imports more than it exports, particularly energy, electronics, gold and machinery.

Textbook economics would treat this as a structural vulnerability. Yet for more than 30 years, India turned it into a strength, powered by foreign investor faith in its long-term trajectory.

Despite chronic trade deficits, India has attracted nearly $1 trillion in FDI since the early 1990s. Our reserves of foreign exchange are among the world’s largest. Global investors have been betting big on our growth prospects, investing in projects or buying stakes in high value companies, enthused by a supportive policy environment, a predictable democracy with strong institutions and an economy capable of delivering sustained high returns.

This is now changing. Net FDI fell from some $40 billion in 2020-21 to about $350 million last year. Two reasons explain this reversal.

First, outbound investment by Indian corporates has surged as they seek global footprints and diversify their markets. This is not a bad signal per se; it signals India Inc’s confidence and integration into global value chains.

Second, foreign investors have been cashing out. High-profile exits—Citibank, Allianz, Ford, MG Motors, Hyundai’s stake in Ola, Whirlpool, Holcim, BAT and others—reflect a big shift. Many of these investors entered India when market penetration was low and consumer aspirations were rising.

But over time, intense competition, regulatory uncertainties and changing global strategies have pushed some of them towards the exit. Repatriation has surged; foreign companies are selling assets, booking profits and reallocating capital to other markets, especially the US, which is now the world’s most attractive FDI destination.

Foreign portfolio investors have also pulled out big money this year; the dollar returns on India’s stock market (MSCI India) underperformed other emerging markets (MSCI Emerging Markets) by the widest margin since 1993. The reasons are many: US tariffs, the absence of a trade deal with Washington, stretched domestic valuations and better opportunities elsewhere.

No wonder the rupee has weakened by more than 5-6% in nominal terms and by nearly 9% in real effective terms. This does not reflect domestic macro instability or inadequate intervention by the Reserve Bank of India (RBI), but a sharp drop in external financing.

With unreliable foreign inflows the new structural reality, we must address our widening trade deficit with a new strategy. We can no longer depend on volatile capital flows to offset the current account deficit. India must strive to transition from a trade-deficit model to a trade-surplus one over the next decade. Note that China’s trade surplus has crossed $1 trillion dollars, giving it a strong cushion.

The world’s undergoing a new phase of industrial policy realignment, with massive subsidies in the US and Europe pulling capital into advanced economies now. India’s attraction of FDI now faces structural headwinds that it did not a decade ago. Foreign investors are insisting on protection through investment treaties. Hence, we need a bold strategy.

First, boost merchandise exports, especially in electronics, machinery, chemicals, garments and automobiles. Second, deepen and widen service exports by building on IT and AI, and moving significantly into projects, design, business services, tourism, education and global capability centres. Third, integrate more deeply with global supply chains, rather than staying partially insulated behind tariff barriers. Fourth, negotiate high-quality trade agreements, particularly with the US, EU and key Asian partners, and also join trade blocs such as RCEP. Fifth, reduce energy import dependence via hydrogen plus solar.

If we turn our trade deficit into a surplus, it will transform our currency dynamics. If we earn more from exports than we spend on imports, we’ll gain resilience against the whims of global capital and rupee stability.

In the near term, we face other pressures. Oil prices are likely to remain benign, thankfully, but gold imports could cost dollars. Unless exports scale up dramatically, the rupee will remain vulnerable. The question is not merely why the rupee is wobbly, but whether we are ready to shift our economic model from one that depends on attracting foreign capital to one that generates foreign earnings through exports.

High growth and low inflation are worthy of celebration. But they cannot, by themselves, anchor a currency. Stability requires a stronger external foundation. If India wants the rupee to reflect its domestic strength, it must urgently address the structural imbalance in its trade account. The long-term solution is not more RBI intervention or temporary capital inflows. It is a strategic national commitment to becoming a net exporter of both goods and services.

The author is senior fellow with Pune International Centre.