Capital outflow | A precarious balance

As missiles and drones once again criss-cross the skies over the Middle East, global markets, rattled by the uncertainty unleashed by the US-Israel war on Iran, brace for the worst. For India, too, the flare-up has revived concerns over its external vulnerabilities and the possibility of a mini balance of payments (BoP) crisis, evoking memories of the pre-liberalisation era.

At its simplest, BoP is a measure of the money flowing into a country versus the money flowing out. Its first pillar is the current account, which tracks trade in goods and services, remittances from Indians working overseas and income from investments. The second is the capital account, which captures foreign investment—both direct investment (FDI) in businesses and portfolio investment (FPI) in financial instruments—as well as overseas borrowing and NRI deposits. For years, deficits on the current account were more than compensated by surpluses on the capital account. Not anymore.

India’s current account deficit (CAD) widened to $30.2 billion (Rs 2.86 lakh crore) in FY26 from $23 billion (Rs 2.18 lakh crore) a year earlier. More troubling was the collapse in the capital account surplus, which shrank to a mere $72 million (Rs 685 crore). It was $89.4 billion (Rs 8.5 lakh crore) just two years ago. The result was a BoP deficit of $30.8 billion (Rs 2.92 lakh crore) in FY26, a steep drop from a surplus of $63.7 billion (Rs 6.05 lakh crore) in FY24, as per the Reserve Bank of India (RBI).

The issue came under sharp focus after Prime Minister Narendra Modi, in an address on May 10, urged citizens to cut back on spending on fuel, gold and foreign travel to reduce the outflow of money. He chose to invoke memories of the COVID-19 years to raise red flags about an economy perched on the edge of stagflation, marked by high inflation and slowing growth. The villain, in this case, was the Middle East crisis.

This is not to say that the situation is as dire as in 1991, when a BoP crisis triggered economic liberalisation. In May, India held foreign exchange reserves of nearly $697 billion (Rs 66.2 lakh crore), enough to cover around 10 months of imports. But the message is one of caution. Costlier oil and gas, pressure on remittances, rising capital outflows and a widening CAD have all weighed on the rupee, which has weakened from around 84 to the dollar a year ago to about 95 today. Concern over these pressures was serious enough for policymakers to unveil a slew of measures on June 5 aimed at shoring up fresh foreign capital.

HIT BY OUTFLOWS

On the face of it, FY26 should have been a strong year for foreign investment. Gross FDI inflows rose to a record $94.53 billion (Rs 8.98 lakh crore) from $80.6 billion (Rs 7.65 lakh crore) in FY25. But a closer look tells a different story. Net FDI, i.e. the amount left after accounting for repatriation by foreign firms and overseas investments by Indian companies, was down to just $7.65 billion (Rs 72,675 crore). In FY25, it had fallen below $1 billion, to $959 million (Rs 9,100 crore). Both figures were a far cry from the $30-40 billion (Rs 2.8-3.8 lakh crore) seen in the pre-pandemic years, notes Dhananjay Sinha, CEO and co-head, institutional equities, Systematix Group. The RBI does not disclose which companies repatriated funds, but the trend has fuelled concerns about India’s ability to attract and retain long-term foreign capital.

“We need to distinguish between three components: one is gross FDI, second is repatriation and third is outward FDI,” explains Madan Sabnavis, chief economist with the Bank of Baroda. Repatriation is the return of profits, dividends and proceeds from asset sales or disinvestment to investors’ home countries. “This number has gone up sharply in the last couple of years, which means companies are taking out money to invest elsewhere or are paying their investors. They are ploughing back less,” says Sabnavis. Such outflows climbed to $53.58 billion (Rs 5.09 lakh crore) in FY26 from $44.47 billion (Rs 4.22 lakh crore) in FY24. “The third component refers to what Indian companies are doing,” he adds. “They are investing more in overseas mergers and acquisitions or in subsidiaries abroad.” These overseas investments rose to $33.29 billion (Rs 3.16 lakh crore) in FY26, nearly double the $16.68 billion (Rs 1.58 lakh crore) two years ago.

As a share of GDP, net FDI peaked at 3.5 per cent in FY08 and now hovers near zero. “This trend indicates that foreign capital is not meaningfully contributing to India’s domestic investment cycle,” says Sinha. This parallels private capex, which has remained lackluster since FY14 despite robust corporate profits in the post-COVID years. According to Sinha, the reasons are both global and domestic. Rising protectionism since 2012, amplified by the US-China trade war, has reduced FDI flows to emerging markets. “Advanced economies have prioritised domestic investment through tax incentives and technology transfer restrictions. Foreign capital, being pro-cyclical, naturally flows toward economies demonstrating strong private sector momentum,” he says.

According to Mihir Vora, chief investment officer at TRUST Mutual Fund, years of strong FDI inflows through funds and corporate investments were always likely to be followed by exits as foreign investors cashed in on their gains. “Funds have a life of 7-15 years. The stock market boom after 2021 gave them a chance to book profits and generate their internal rates of return,” he says. Rising valuations also enabled several foreign companies to list in India, after which “a large chunk of the money raised was transferred to the home country”.

Experts, however, draw a distinction between the repatriation of profits, which falls under the current account, and disinvestment by MNCs, which is recorded in the capital account. “While repatriation of profits is a natural process, why the disinvestment?” asks trade expert Biswajit Dhar. “Lower net FDI is concerning because FDI represents stable, long-term capital and comes with managerial expertise and strategic commitment. Why is India unable to retain long-term funds?” Part of the answer lies in India’s own challenges. While economic growth remains robust on paper, it has not translated into broad-based opportunities in manufacturing and other employment-intensive sectors. Earnings growth for Nifty companies averaged just 3.5 per cent between FY14 and FY19, while recent trends point to a return to subdued profitability. The rupee has also depreciated sharply since 2012—roughly twice as fast as the broader emerging-market currency index—eroding dollar returns for foreign investors.

Meanwhile, there was some relief on the current account front. India posted a surplus of $7.1 billion (Rs 67,500 crore) in Q4FY26, reversing a deficit of $15.5 billion (Rs 1.47 lakh crore) in the previous quarter. Such surpluses are not unusual in the final quarter of a financial year and, this time, were aided by a stronger surplus in services trade. But the respite may prove temporary. “We expect CAD to widen to 2.2 per cent of GDP this fiscal (FY27), up from 0.6 per cent last fiscal,” says Dharmakirti Joshi, chief economist at Crisil. Costlier crude oil, natural gas and fertilisers are expected to push up India’s import bill, while exports could come under pressure from global trade disruptions and weakening demand, he says. Remittances from the Gulf region—which account for about 38 per cent of the total—also face pressure.

SHORING UP FOREIGN FUNDS

Against this backdrop, the June 5 package marked India’s first major response to mounting pressures on its external accounts. The RBI unveiled measures aimed at attracting foreign capital. These included a temporary facility, until September 30, to lower the cost of external commercial borrowings (ECBs) by public sector undertakings, besides incentives for NRIs to make fresh fixed-term deposits of their overseas earnings in stable foreign currencies with Indian banks.

The Centre complemented the RBI’s efforts with measures aimed at attracting more FPI into government securities. These included streamlined investment norms, expanded access to government bonds, and tax exemptions on interest income and capital gains. “As a result of these measures (on ECBs, etc.) and initiatives taken by the government on bonds and trade agreements, we are confident of a very healthy BoP, compared to what would have been otherwise,” said RBI governor Sanjay Malhotra.

Experts say the steps should help improve capital inflows, deepen bond markets, support liquidity and provide some relief to the rupee. “The slew of reforms announced pivot the policy stance to a progressive and daring one. It augurs well for the economy and markets while keeping the growth momentum sacrosanct,” says Soumya Kanti Ghosh, group chief economic advisor at State Bank of India.

Yet these measures address only part of the problem. They may attract more portfolio flows and help Indian companies raise funds abroad, but reversing the slide in net FDI will require deeper reforms. “Investment requires certain prerequisites—good infrastructure, transparent rules, single-window clearances and better Centre-state coordination,” says Dhar. “For many foreign investors, the biggest concern has been the long pendency of cases in Indian courts.” The challenge is not just to attract capital, but to retain it—by creating an environment where businesses can grow profitably and foreign investors see India as a long-term destination for investment.