India appears to be facing one of its toughest economic challenges in recent years. Oil, gold, fertiliser, and other commodity prices remain elevated. Foreign portfolio investors continue to sell, imports stay unabated, exports face headwinds, and remittances from the Middle East may be impacted. All these factors are feeding into an economy where a depreciating rupee adds to the woes.
Chief Economic Advisor V Anantha Nageswaran has described the current situation as a live balance of payments stress test. His words could not be more direct, and the challenges faced by the world’s sixth-largest economy are substantial. Several macroeconomic indicators are under scrutiny: inflation, the health of the current account, and the exchange rate.
Why Is It a Stress Test?
Multiple stress factors have been activated simultaneously. India depends on the Middle East for a large percentage of its energy imports, fertilisers, and fertiliser feedstock gas. A large diaspora in the Middle East generates significant remittances, while the region is also one of India’s biggest export destinations. Any disruption in these channels directly impacts the balance of payments.
Understanding the Balance of Payments
Every country keeps a detailed record of its financial transactions with the rest of the world, known as the Balance of Payments (BoP). It is a critical indicator of economic health, reflecting foreign exchange inflows and outflows. Inflows include exports, investments, remittances, and foreign loans; outflows include payments for imports, overseas travel, investments abroad, and debt repayments. A surplus occurs when inflows exceed outflows, while a deficit arises when outflows are higher.
The BoP directly affects a country’s currency, foreign exchange reserves, inflation, and economic stability. For India, which imports nearly 90% of its crude oil and about 50% of its gas needs, managing foreign exchange is critical. If demand for dollars rises sharply, the rupee weakens, making imports more expensive and adding to inflationary pressure.
According to a recent JPMorgan report, net capital inflows into India averaged 2.6% of GDP between 2015 and 2019 but fell to 1.4% in 2024 and nearly disappeared in 2025. The slowdown is driven by falling foreign direct investment and sustained selling by foreign portfolio investors.
Why Is India's BoP Under Pressure?
India’s external sector faces pressure from multiple fronts. Rising geopolitical tensions involving Iran and disruptions around the Strait of Hormuz have pushed up global crude oil prices. The higher energy bill is expected to widen India’s current account deficit significantly. Economists estimate the deficit could rise to 2.5% of GDP in FY27 from 0.9% in the previous year, as reported by Reuters.
India’s overall BoP deficit is expected to widen to between $65 billion and $70 billion this year, marking the third consecutive year of deficits. HSBC noted that India faces a twofold challenge: to lower the current account deficit and attract sustainable capital inflows. Higher oil prices are already affecting the trade balance, with the merchandise trade deficit widening to $28.38 billion in April due to a surge in crude oil imports to a six-month high.
Adding to concerns, the capital account is under pressure from unprecedented foreign portfolio investor withdrawals. Since the outbreak of the Iran conflict, overseas investors have withdrawn more than $20 billion from Indian equities, pushing total outflows in 2026 beyond last year’s record levels. This pressure has weakened the rupee by over 5% since the Iran war started.
Radhika Rao, Executive Director and Senior Economist at DBS Bank, told TOI: “Barring a sharp improvement in portfolio flows and net FDI in the second half of the year, the BoP is likely to register a deficit for the third consecutive year, setting the stage for slower reserve accretion and further rupee underperformance.”
Ranen Banerjee, Partner and Leader, Economic Advisory, PwC India, explained that strong invisibles like remittances and robust service exports have supported the current account. However, risks arise from a dip in remittances, AI-related threats to services exports, and export headwinds from tariffs and geopolitical conflicts.
The last time India saw consecutive BoP deficits was after the global oil crisis of the 1970s. Vivek Kumar, Economist at QuantEco, attributed the stress to the global pivot on capital flows in the post-COVID era, marked by rising protectionism and supply chain redrawing. The ongoing Middle East crisis has added further risk. He expects the rupee to weaken to 96.5 by end-FY27, with depreciation risks accentuated if the crisis persists.
DK Srivastava, Chief Policy Advisor, EY India, warned that India’s BoP position reflects deep-seated structural forces. He noted: “If it is a test, India may not come out on top as the pressures arise from structural forces governing the global economy and trade.” India imports nearly 90% of its crude oil and nearly 60% of its LPG, subjecting it to price and supply shocks. This could have implications for growth in the short to medium term.
Srivastava sees some deterioration in the current account deficit (CAD) in the final quarter of 2025-26, though it may remain below 2% of GDP. However, given the sharp rise in crude oil prices, CAD could approach 2% of GDP in 2026-27, against a sustainable level of 1.3%.
Historical Context
India’s economic history highlights the importance of external sector stability. Major BoP-shaping events include the 1966 rupee devaluation, the oil shocks of 1973 and 1980, the 1991 BoP crisis, the 1997 East Asian crisis, the Y2K technology boom, and the 2008 global financial crisis. The 1991 crisis remains the most significant, demonstrating the vulnerability of an economy with unchecked external imbalances.
Is a Structural Crisis Looming?
CEA Nageswaran has described the Middle East conflict exposure as structural, warning that data readings will not self-correct. He highlighted four structural shifts: technology bifurcation, energy transition used as industrial policy, geo-economic fragmentation, and geopolitical risk. India must prepare for a prolonged phase of these challenges.
Experts express confidence in India’s fundamentals but warn of a prolonged conflict’s impact. Ranen Banerjee noted that lower inflation provides headroom, and healthier corporate and bank balance sheets can absorb stress. The fiscal position is strong enough to support the economy through a slightly higher deficit. India has also anticipated challenges by entering bilateral trade agreements and expanding BRICS trade.
However, EY’s Srivastava stressed that the West-Asian crisis has accentuated the BoP crisis, exposing India’s vulnerability to global shocks. He called for recalibration of growth strategy to achieve Viksit Bharat status in two decades. Early signs of pressure include rupee depreciation and tightening fiscal and current account deficits. He advocated for domestic policies to mitigate fiscal pressure and expansion of India’s share in intra-BRICS trade and bilateral agreements.
As CEA Nageswaran stated: “Managing the current account credibly, financing it, and preventing further currency depreciation are the central macroeconomic imperatives of FY27. India's fiscal consolidation path, infrastructure investment, and reform record provide the foundation.”
