India's external account showed a significant year-on-year improvement in the second quarter of the current financial year, with the current account deficit (CAD) narrowing sharply. The deficit stood at $12.3 billion, or 1.3% of the Gross Domestic Product (GDP), for the July-September quarter (Q2) of FY 2025-26. This marks a substantial improvement from the deficit of $20.8 billion, or 2.2% of GDP, recorded in the same quarter a year earlier (July-September 2024).
Quarterly and Half-Yearly Trends Show Contrasting Pictures
While the annual comparison is positive, a sequential view reveals a different story. The CAD deteriorated from the preceding April-June 2025 quarter (Q1), where it was a modest $2.4 billion, or 0.2% of GDP. This quarter-on-quarter widening of about $9.6 billion was primarily driven by a sharp expansion in the merchandise trade deficit.
For the first half of FY26 (April-September 2025), the overall current account gap declined to $15 billion, or 0.8% of GDP. This is lower than the $25.3 billion, or 1.3% of GDP, recorded in the corresponding half of the previous fiscal year.
Key Drivers Behind the Annual Improvement
The narrowing of the annual deficit was supported by multiple factors. The merchandise trade deficit saw a modest contraction to about $87.4 billion from $88.5 billion a year ago. More significantly, net services receipts rose robustly to $50.9 billion from $44.5 billion, bolstered by strong performance in computer services exports.
Furthermore, secondary income, which includes personal remittances from Indians working abroad, strengthened considerably. Receipts under this head increased to $38.2 billion from $34.4 billion. However, these gains were partially offset by higher primary income outflows (such as investment income payments), which rose to $12.2 billion from $9.2 billion.
Gold import trends were mixed. Net gold imports for Q2 FY26 at $19,029 million were lower than the $20,691 million in Q2 FY25. However, they were significantly higher than the $7,486 million imported in the immediate preceding quarter (Q1 FY26).
Financial Flows and Reserve Movement
Financial account flows presented a mixed bag during the quarter. There was a welcome reversal in Foreign Direct Investment (FDI), which recorded a net inflow of $2.9 billion compared to a net outflow of $2.8 billion a year ago.
In contrast, Foreign Portfolio Investment (FPI) witnessed a net outflow of $5.7 billion, a stark shift from the substantial net inflow of $19.9 billion in the year-ago quarter. Other inflows also slowed: external commercial borrowings fell to $1.6 billion from $5 billion, and Non-Resident Indian (NRI) deposit inflows reduced to $2.5 billion from $6.2 billion.
On a balance-of-payments basis, the overall outcome was a decline in foreign exchange reserves by $10.9 billion during the quarter. This reverses the accretion of $18.6 billion seen in the same period last year, reflecting the pressures from certain financial outflows and the widened quarterly CAD.
Analysis and Implications
The data underscores the resilience of India's core foreign exchange earners—software services and remittances—which continue to provide a strong buffer against the merchandise trade deficit. The sharp sequential deterioration, however, highlights the volatile nature of trade flows and the impact of global commodity prices.
The shift in financial flows, with FDI turning positive but FPI turning negative, points to changing investor sentiment and global financial conditions. The drawdown in reserves, while notable, comes from a historically high base and reflects the central bank's likely intervention to manage currency volatility amidst global headwinds.
Moving forward, the sustainability of a manageable current account deficit will hinge on the trajectory of global growth impacting exports, the trend in crude oil and gold imports, and the stability of financial inflows.
