Time bought, not problems solved

India’s buffers can manage markets for now, but hard policy choices still lie ahead

- ANANTH NARAYAN

India is navigating uncertainties arising from the US-Israel-Iran conflict. Economic and regulatory buffers are in place, and markets have priced in higher risk. However, macroeconomic vulnerabilities remain. India needs more investments and innovation. To this end, appropriate policies can help address external and fiscal imbalances, attract foreign investment, and better support balanced growth.

Markets, flows, and regulations

India has been managing a persistent external imbalance. In FY25, India experienced a core external deficit of $38 billion, across its current account deficit (CAD), net foreign direct investment (FDI), and net equity foreign portfolio investment (FPI). This expanded to $40-45 billion in FY26 and could rise to $50 billion in FY27.

Against this, the Reserve Bank of India (RBI) has an estimated $585 billion in foreign currency reserves net of forward sales. This buffer provides India time for adjustment.

However, through FY25 and FY26, the RBI had to net supply around $195 billion of foreign exchange, significantly higher than the estimated $80 billion of core deficit.

Around $115 billion of demand was, therefore, driven not by core deficits, but by hedging and speculation. The offshore rupee non-deliverable forward (NDF) market is key to this dynamic.

Given capital account restrictions, domestic participants cannot freely speculate in currency markets. No such constraints apply to offshore participants in NDF markets. A few years ago, the RBI permitted Indian banks to arbitrage onshore and NDF markets, aligning pricing and liquidity across both.