Rupee and Capital Account Problem

Context

1. The rupee has weakened sharply against major currencies in the last year:
   84. Against the US dollar: from about ₹84.7 to ₹89.9
   85. Also weaker against the euro, pound, yen and yuan.
2. This fall is happening even though the current account deficit (CAD) is not very high and is declining.
3. The main reason is a capital account problem – foreign capital inflows into India have dropped sharply.

What is Balance of Payment?

1. The Balance of Payments records all economic transactions of India with the rest of the world. It has two main parts:
   1. Current Account
   2. Capital Account (plus financial account)

What is a Capital Account?

1. The capital account / financial account records cross-border flows of money and investments, such as:
   1. Foreign Direct Investment (FDI)
   2. Foreign Portfolio Investment (FPI)
   3. External commercial borrowings
   4. External assistance (loans, aid)
   5. NRI deposits and other capital flows

What is a Current Account?

1. The current account shows exports and imports of goods and services, plus income and transfers (like interest, dividends, remittances).
2. It has two main subcomponents:
   1. Merchandise Trade (Goods Trade Balance)
      1. Exports and imports of physical goods.
      2. India’s goods trade balance has always been in deficit.

• The goods trade deficit:
  1. Around $91.5 billion in 2007-08
  2. More than doubled to $195.7 billion in 2012-13
  3. Narrowed to $112.4 billion in 2016-17 and $102.2 billion in 2020-21
  4. Then widened sharply to about $286.9 billion in 2024-25
  5. Likely to cross $300 billion in 2025-26, based on trends till September 2025.

1. Invisibles (Services, Transfers, Income, etc.)
   1. These are non-physical transactions:
      1. IT and software services
      2. Business and financial services
      3. Remittances from Indians working abroad
      4. Other professional and miscellaneous services
   2. India gets large surpluses here because receipts from services and remittances are much higher than payments like interest, dividends, royalties, and education abroad.

• The invisibles surplus:
  1. About $75.7 billion in 2007-08
  2. Around $150–151 billion by 2021-22
  3. Rose to about $263.9 billion in 2024-25
  4. Likely to top $280 billion in 2025-26.

3. These strong invisibles show India is becoming the “office of the world” (IT engineers, accountants, doctors, nurses, etc.), just as China is called the “factory of the world”.

What is Current Account Deficit (CAD)?

1. CAD refers to the difference between the value of imports and exports of goods, services, and income flows.
2. If a country imports more than it exports, it has a current account deficit.
3. India has historically had a structural CAD, with only four years of surplus in the last 25+ years: 2001-02, 2002-03, 2003-04 and 2020-21.

How has India managed CAD so far?

1. India has a structural CAD – that means it is usually in deficit.
2. In the last 25+ years, India had current account surpluses in only four years:
   3. 2001-02: $3.4 billion
   4. 2002-03: $6.3 billion
   5. 2003-04: $14.1 billion
   6. 2020-21: $23.9 billion
3. CAD peaks:
   78. 2011-12: about $78.2 billion
   79. 2012-13: about $88.2 billion
4. In most other years CAD stayed below $50 billion, except 2018-19 and 2022-23 (around $57.3 billion and $67.1 billion).
5. Recently, CAD has declined:
   25. April-September 2024: about $25.3 billion
   26. April-September 2025: about $15.1 billion
6. So, CAD is present but not exploding because the invisibles surplus almost offsets the goods deficit.

Why Does the Rupee Have a Capital Account Problem (Not a Current Account Problem)?

1. From the BoP side, CAD is manageable and falling.
2. However, the rupee is still falling because:
   1. Capital inflows have reduced sharply and are no longer enough to finance the CAD comfortably.
   2. Both FDI (long-term investment like factories) and FPI (investment in stock markets) have reduced. Investors are pulling money out instead of bringing money in.
   3. India has strong GDP growth, but foreign investors are still not investing. Because less capital is coming in, the rupee is becoming weaker against the dollar and other currencies.
3. Earlier, the capital inflows were higher than CAD, so India could finance the deficit easily and still add to forex reserves.
4. Now, capital inflows are lower than CAD, so forex reserves face pressure, and the rupee weakens.

Implications of the Framework

1. Rupee Weakness: Continued pressure on the rupee makes imports costlier (especially oil, machinery, electronics).
2. Imported Inflation: Higher import costs can raise domestic prices, adding to inflation risk.
3. Investment and Jobs: Lower FDI means fewer new factories and infrastructure projects, affecting job creation.
4. External Vulnerability: If capital inflows remain low, India may find it harder to finance CAD comfortably and build reserves.
5. Disconnect: There is a worrying gap between high GDP growth and low foreign investor interest.

Challenges and Way Forward

Conclusion

India’s rupee is weakening not because of a rise in the current account deficit but due to a sharp fall in foreign capital inflows, which has created a capital account problem. Strong invisibles are controlling CAD, but without adequate foreign investment, financing deficits and stabilising the rupee will be difficult. India needs sustainable, long-term foreign capital to strengthen currency stability.