Rupee’s Fall Driven by Capital Account Stress

Why in the News ?

India’s persistent current account deficit (CAD) remains a structural challenge, yet the recent sharp weakening of the rupee is being driven not by the CAD but by severe stress in capital inflows. This shift highlights that India’s external vulnerability now lies in the capital account rather than the current account.

Background & Context

• In the past 25+ years, India has recorded a current account surplus only four times: 2001–02, 2002–03, 2003–04, and 2020–21.
• CAD peaked at $78.2 bn (2011–12) and $88.2 bn (2012–13); stabilised below $50 bn afterward, except in 2018–19 ($57.3 bn) and 2022–23 ($67.1 bn).
• Despite large merchandise trade deficits, India has avoided crises due to strong surpluses in invisibles—services, remittances, professional exports.

India’s Current Account: The Role of the Invisible Hand

1. Two Components of the Current Account

• Merchandise Trade: Exports & imports of physical goods
• Invisibles: Services, remittances, intellectual property, professional services, data flows

2. Merchandise Trade Deficit Keeps Widening

• $91.5 bn (2007–08)
• Peak: $195.7 bn (2012–13)
• Narrowed: $102.2 bn (2020–21)
• Jumped: $286.9 bn (2024–25)
• Likely to cross $300 bn in 2025–26

3. Invisibles Surplus: India’s Cushion

Drivers of large surpluses:

• Private remittances
• IT and ITeS exports
• Consulting, design, finance & medical services

Payments offset by this surplus include:

• Interest/dividends to foreign investors
• Royalties
• Foreign education spending

Surplus growth:

• $75.7 bn (2007–08)
• $150.7 bn (2021–22)
• $263.9 bn (2024–25)
• Expected: $280+ bn this year

4. Why CAD Remains Manageable

The invisibles surplus cushions the merchandise deficit, keeping the CAD from exploding despite weak goods exports.

5. India as the “Office of the World”

• China = “factory of the world”
• India = “office of the world”
• Exporting: IT, finance, accounting, medicine, design, auditing, and professional services → Acts as a stabiliser against goods import pressures.

CAD Is Not the Problem — Capital Flows Are

1. CAD Has Actually Reduced

• $25.3 bn (Apr–Sep 2024) → $15.1 bn (Apr–Sep 2025)
• Yet the rupee has fallen sharply against major currencies.

2. Rupee Depreciation Across Currencies

• USD: 84.73 → 89.92
• Euro: 89.20 → 104.82
• Pound: 107.76 → 120
• Yen: 0.5658 → 0.5815
• Yuan: 11.66 → 12.72

This drop is linked to weakening capital inflows, not import-heavy trade.

Collapse in Capital Inflows: The Core Pressure Point

1. Capital Inflows at Multi-Year Lows

Earlier: capital inflows comfortably exceeded CAD and boosted forex reserves.

Now:

• $18 bn (2024–25) — below CAD
• $8.6 bn (Apr–Sep 2025) — again below CAD

This imbalance directly weakens the rupee.

Sharp Decline in FDI and Portfolio Flows

Foreign Investment (Overall)

• $80.1 bn (2020–21)
• $21.8 bn (2021–22)
• $22.8 bn (2022–23)
• $54.2 bn (2023–24)
• $4.5 bn (2024–25)
• $3.6 bn (Apr–Sep 2025)

FDI Decline

• $44 bn (2020–21)
• $38.6 bn (2021–22)
• $28 bn (2022–23)
• $10.2 bn (2023–24)
• $959 mn (2024–25)
• Slight recovery: $7.7 bn (Apr–Sep 2025)

FPI Trends

• Net outflows: –$18.5 bn (2021–22)
  • –$5.1 bn (2022–23)
• Only 2023–24 saw net inflows
  • –$14.6 bn (2024–25)
  • –$4.3 bn (2025–26 so far)

Why This Is Surprising

India has maintained 8.2% average GDP growth since 2021–22 and 8% growth in the first half of 2025–26. Ordinarily, such growth attracts foreign capital — yet investors have been exiting, creating a capital account deficit.

Capital Dry-Up: The Real Reason Behind Rupee Weakness

• The rupee’s fall is not due to CAD or rising imports.
• It stems from shrinking capital inflows, reducing dollar supply.
• The capital account is now India’s main external vulnerability.