India’s Growth Paradox: Strong GDP, Weak Foreign Capital Inflows

Why in the News?

1. Despite being the world’s fastest-growing major economy, India is witnessing an unusual decline in foreign capital inflows.
2. Net capital inflows during 2024-25 stood at only 18.3 billion US dollars, the lowest since the global financial crisis year of 2008-09.
3. In the current fiscal year (April-June 2025), capital inflows fell further by over 40 percent compared to April-June 2024, raising concerns about investor confidence and external sector stability.

Key Highlights

1. India’s Growth versus Capital Inflows
   8. India’s Gross Domestic Product (GDP) grew at an average annual rate of 2 percent between 2021-2024, higher than other major economies such as Vietnam (5.8 percent), China (5.5 percent), Malaysia (5.2 percent), Indonesia (4.8 percent), and developed economies such as the United States (3.6 percent) and the European Union (2.8 percent).
   9. In 2025, India sustained its momentum with GDP growth of 4 percent in January-March and 7.8 percent in April-June.
   10. Normally, high economic growth should attract foreign capital, but this correlation appears to have broken down.
2. Foreign Portfolio Investment (FPI) Trends
   25. In the past five financial years, only 2023-24 recorded net inflows of 25.3 billion US dollars into Indian equities.
   26. Other years saw net outflows: 5 billion US dollars (2021-22), 5.1 billion US dollars (2022-23), 14.6 billion US dollars (2024-25), and 2.9 billion US dollars in 2025-26 till early September.
   27. This suggests that portfolio investors are exiting Indian markets despite strong domestic growth.
3. Foreign Direct Investment (FDI) and Private Equity/Venture Capital (PE/VC)
   80. Net foreign investment peaked at 1 billion US dollars in 2020-21, driven largely by FDI and private equity/venture capital inflows.
   81. Thereafter, FDI dropped sharply: 8 billion US dollars (2021-22), 22.8 billion US dollars (2022-23), 54.2 billion US dollars (2023-24), and only 959 million US dollars in 2024-25.
   82. Much of the earlier FDI was private equity and venture capital investment in retail, e-commerce, financial services, renewable energy, healthcare, and real estate.
   83. Investors who entered around the mid-2010s are now exiting through Initial Public Offerings (IPOs) and stake sales, monetising mature positions: 24 billion US dollars (2022), 29 billion US dollars (2023), and 33 billion US dollars (2024) in exits.
4. Balance of Payments (BoP) Data
   91. India’s merchandise trade deficit has ballooned: from 4 billion US dollars in 2007-08 to 287.2 billion US dollars in 2024-25.
   92. This was offset by a strong invisibles surplus (mainly services exports and remittances): 8 billion US dollars in 2024-25.
   93. As a result, the current account deficit was restricted to 37 billion US dollars in 2024-25, much lower than the trade deficit alone would imply.
   94. However, this deficit requires stable capital inflows for financing, which are now under pressure.
5. Global and Domestic Factors Affecting Investor Sentiment
   86. Global risks: The announcement of 50 percent tariffs by US President Donald Trump on Indian goods could derail exports to the United States, which accounted for 5 billion US dollars of India’s total merchandise exports in 2024-25.
   87. Domestic concerns:
       1. Indian stock markets are considered overvalued, prompting profit-booking by foreign investors.
       2. Corporate earnings have not risen in proportion to GDP growth.

• Concerns about ease of doing business, taxation unpredictability, and policy execution still persist.

1. These factors are leading to a cautious approach by overseas investors.

Key Terms

1. Capital Inflows
   1. These are the movement of money into a country for investment, loans, or deposits.
   2. Capital inflows include Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), External Commercial Borrowings (ECBs), and Non-Resident Indian (NRI) deposits.
   3. They are recorded in the capital account of the BoP.
   4. Higher inflows strengthen the rupee and increase foreign exchange reserves, while lower inflows create external financing pressure.
   5. Excessive dependence on volatile inflows (like FPI) can cause sudden reversals, leading to currency depreciation and market instability.
2. Balance of Payments (BoP)
   1. BoP is a systematic record of all economic transactions between residents of a country and the rest of the world during a given period (usually one year).
   2. It has two main accounts: the Current Account (trade in goods, services, remittances) and the Capital Account (investment flows, loans, borrowings).
   3. A BoP surplus means the country has more inflows than outflows of foreign currency, while a deficit means the opposite.
   4. In India, BoP data is published by the Reserve Bank of India (RBI).
   5. A healthy BoP is essential to maintain foreign exchange reserves, currency stability, and external sector credibility.
3. Trade Balance
   1. Trade balance is the difference between the value of a country’s exports of goods and its imports of goods.
   2. A trade surplus occurs when exports > imports, while a trade deficit occurs when imports > exports.
   3. India generally runs a large trade deficit due to high imports of crude oil, gold, and electronics.
   4. Persistent trade deficits put pressure on the current account and foreign exchange reserves.
   5. Trade balance is only one part of the current account and does not include services or remittances.
4. Invisibles Balance
   1. Invisibles refer to services, remittances, and investment income which are not visible as physical goods.
   2. Examples: IT services exports, tourism receipts, shipping, insurance, and money sent home by Non-Resident Indians (NRIs).
   3. India consistently runs a large surplus in invisibles, thanks to IT services exports and remittances.
   4. This surplus helps to offset the merchandise trade deficit, making the current account more sustainable.
   5. A strong invisibles balance is a key strength of India’s BoP structure.
5. Current Account
   1. The current account records the net flow of goods, services, income, and transfers between a country and the world.
   2. Formula: Current Account = Trade Balance + Invisibles Balance.
   3. A Current Account Deficit (CAD) means the country is spending more foreign exchange on imports and transfers than it earns from exports and inflows.
   4. India often has a CAD, but it is usually below 3 percent of GDP, considered manageable.
   5. Financing the CAD requires capital inflows; otherwise, foreign exchange reserves may decline.
6. Foreign Direct Investment (FDI)
   1. FDI refers to long-term investment by foreign entities in business operations or assets in another country (factories, infrastructure, ownership stakes).
   2. It is considered stable and long-lasting compared to portfolio investment.
   3. In India, sectors such as IT, telecom, renewable energy, and manufacturing attract FDI.
   4. FDI brings not just capital but also technology transfer, management practices, and employment generation.
   5. Policies such as the Make in India initiative and Production Linked Incentive (PLI) scheme aim to increase FDI.
7. Foreign Portfolio Investment (FPI)
   1. FPI refers to short-term investments by foreign investors in stocks, bonds, and other financial assets of a country.
   2. Unlike FDI, FPIs do not involve management control; they are purely financial investments.
   3. FPIs are highly volatile and can enter or exit a country quickly depending on global and domestic conditions.
   4. Large FPI outflows often lead to currency depreciation and stock market instability.
   5. India regulates FPIs through the Securities and Exchange Board of India (SEBI).
8. Private Equity (PE) and Venture Capital (VC)
   1. Private Equity (PE) refers to investment in established companies, often through buyouts or large stakes, to improve operations and eventually sell for profit.
   2. Venture Capital (VC) refers to investment in start-ups or early-stage companies with high growth potential.
   3. Both PE and VC are important for innovation, entrepreneurship, and expansion of emerging sectors.
   4. These investors eventually seek exits by selling shares through Initial Public Offerings (IPOs) or mergers and acquisitions.
   5. In India, sectors like e-commerce, fintech, healthcare, and renewable energy have attracted large PE/VC investments.
9. Initial Public Offering (IPO)
   1. IPO is the first sale of shares by a company to the public to raise capital from the stock market.
   2. It allows PE and VC investors to exit by selling their stakes to new investors.
   3. IPOs increase company visibility and help in raising funds for expansion.
   4. In India, IPOs are regulated by the Securities and Exchange Board of India (SEBI).
   5. A booming IPO market reflects strong investor demand but can also encourage overvaluation.

• Gross Domestic Product (GDP)
  1. Definition: GDP is the total monetary value of all final goods and services produced within a country’s borders in a given period (usually a quarter or a year).
  2. Measurement Approaches:
     1. Production approach: Sum of value added at each stage of production.
     2. Expenditure approach: Consumption + Investment + Government Spending + (Exports – Imports).

• Income approach: Sum of incomes earned (wages, profits, rents, interest).

1. Types:
   1. Nominal GDP: Calculated at current market prices.
   2. Real GDP: Adjusted for inflation, gives a better picture of growth.

• GDP per capita: GDP divided by population, indicating average income.

1. Importance: It is the primary indicator of economic growth and is used to compare the performance of economies globally.
2. Limitations: GDP does not measure income distribution, informal sector output, or environmental sustainability.

Implications

1. External Sector Stability
   1. Declining capital inflows may put pressure on India’s foreign exchange reserves, reducing its buffer against global shocks.
   2. Financing of the current account deficit could become more challenging if capital inflows continue to decline.
2. Exchange Rate Volatility
   88. Capital outflows have contributed to the Indian rupee depreciating to a record low of 88.37 per US dollar.
   89. A weaker currency increases the cost of imports, particularly crude oil, and adds to inflationary pressures.
3. Investor Confidence
   1. The persistent exits by foreign portfolio investors and private equity/venture capital funds indicate skepticism about sustainability of returns.
   2. Domestic investors have cushioned markets so far, but the absence of foreign participation reduces liquidity and global confidence.
4. Impact on Trade and Exports
   1. With the United States imposing steep tariffs, India’s merchandise exports face new risks.
   2. Dependence on services exports and remittances for balancing the BoP may become unsustainable if goods exports weaken further.
5. Policy Responses and Reform Push
   1. The Government of India has reduced Goods and Services Tax (GST) rates to boost domestic consumption and corporate profitability.
   2. A Task Force for Next-Generation Reforms has been proposed to improve ease of doing business, attract long-term capital, and signal stability to foreign investors.

Challenges and Way Forward

Conclusion

India presents a paradox: it is the fastest-growing major economy with impressive GDP figures, yet it is struggling to attract foreign capital at the scale expected. Past inflows are being withdrawn by private equity and venture capital funds, while foreign portfolio investors remain cautious due to high market valuations and uncertain global conditions. The ballooning trade deficit, rupee depreciation, and tariff shocks add to the vulnerability. To sustain growth and external stability, India must focus on long-term, stable Foreign Direct Investment, diversify exports, strengthen corporate earnings, and deliver credible next-generation reforms. A clear, predictable, and investor-friendly policy environment will be key to converting the “India Growth Story” into an equally strong “India Investment Story.”