India's Rupee Struggles: A Deep Dive into Balance of Payments Challenges

India's Foreign Exchange Reserves Decline Amid Challenging Capital Flows

Current Account Deficit (CAD) of 1.1% for FY26

India's Foreign Exchange Reserves (FER) have recorded a net decline of $5 billion in FY25 and $31 billion in April-December FY26, excluding valuation adjustments. This decline is unusual, given that India's currency and reserve challenges have historically been driven by stress in the Current Account Deficit (CAD). However, in this instance, the headline CAD appears manageable at 1.1% for FY26.

Capital Flows: A Key Factor

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India's structural CAD, characterized by higher imports than exports, is typically funded by capital inflows. Historically, years of surpluses in capital flows have led to accretion of reserves. However, in recent times, capital inflows have become challenging. Foreign Portfolio Investors (FPI) net outflows have been a concern, driven by geo-political tensions and higher yields. Additionally, Foreign Direct Investment (FDI) outflows in equity have reached unprecedented levels, with investors exiting mature investments.

FDI Trends and Reinvested Earnings

FDI outflows in equity have been significant, with the share of reinvested earnings increasing to 25-27% from 20-22% in FY19-22. While the pace of gross FDI has moderated, the increase in reinvested earnings has put net FDI under pressure. As India's GDP has risen from $3.2 trillion in FY22 to $4 trillion in FY26, FDI growth has not kept pace with economic expansion.

RBI Actions and Near-Term Challenges

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The Reserve Bank of India (RBI) has been active in both spot and forward markets, with a net sold forward book of $53.3 billion in August 2025. The RBI has also been purchasing government bonds to keep yields range-bound. However, the current scenario is more challenging than indicated by headline numbers. The RBI's actions may be guided by the consensus that war-related stress will abate soon, but India's capital challenges may require longer-term solutions.

Key Statistics

• Foreign Exchange Reserves (FER): 79% Foreign Currency Assets (FCA), 18% Gold, 3% Special Drawing Rights (SDR) and Reserve Tranche Position (RTP)
• Net sold forward book: $53.3 billion in August 2025
• FDI outflows in equity: unprecedented levels
• Share of reinvested earnings: 25-27% (FY19-22)
• India's GDP: $3.2 trillion (FY22) to $4 trillion (FY26)