A Regime Shift for India’s BoP

India’s Balance of Payments is witnessing a regime shift. The incidence of a net BoP deficit has picked up noticeably since the COVID period, with the frequency of deficits estimated at about 57% in the post-COVID phase¹, exceeding the pre-liberalisation frequency of about 49%.

Chart 1: India’s BoP facing a regime shift?

Note: Figures in parentheses indicate the number of years; GFC stands for the Global Financial Crisis; ‘Since COVID’ phase covers the FY21-FY27 period.

Source: CIEC and QuantEco Research

India has established itself as the fastest-growing major economy in the post-COVID period. This phase has also been marked by a reduction in India’s trend rate² of Current Account Deficit to 1% of GDP, down from 2.1% just before the COVID period. A structural buoyancy in services exports, driven by the proliferation of Global Capability Centres and the rise of the domestic fintech sector, has been notable. In value terms, services exports have risen to about 95% of merchandise exports on an annualised basis, from about 59% a decade ago, and the services trade surplus is projected to reach a record 5.5% of GDP in 2025–26.

Despite these positive macro undercurrents, the challenges confronting India’s BoP remain. The questions are what explains this shift, how policymakers should navigate the new regime, and what it implies for market participants.

Capital Realignment
India’s capital account, which historically ran a comfortable surplus that more than financed the CAD and resulted in a BoP surplus, adding to foreign exchange reserves, has weakened materially. The trend rate² of the capital account surplus has declined to about 2% of GDP at present, down from 3.2% just before COVID. Notably, in recent years, 2024–25 and 2025–26, the capital account surplus has struggled to exceed even 0.5% of GDP.

The post-COVID phase has coincided with elevated geoeconomic and geopolitical uncertainty. There has been a perceptible increase in populism and protectionism worldwide, affecting economic policies, trade, supply chains, and capital flows. The gradual erosion of multilateralism is contributing to economic fragmentation, with countries resorting to reshoring, nearshoring, and friendshoring to reconfigure supply chains. The IMF has described this as a phase in which global linkages are changing amid heightened geopolitical tensions, with policy efforts increasingly focused on supply-chain resilience and national security³. 

Chart 2: Capital flows adjusting to a new world order

Source: Economic Policy Uncertainty, CEIC, and QuantEco Research

While this has not led to a perceptible surge in capital controls, global investment flows are facing headwinds from heightened uncertainty linked to industrial policy, trade protectionism, climate transition, and AI-driven technological competition.

In the pre-COVID phase, growth prospects, return differentials, and risk appetite guided global capital flows. In recent years, capital allocation has increasingly been shaped by geopolitical alignment, investment screening, technology controls, ownership of critical minerals, and regulatory arbitrage. The resulting financial fragmentation matters particularly for emerging markets, as their external financing conditions depend not only on domestic fundamentals but also on global risk appetite, dollar liquidity, and geopolitical positioning.

India’s Position
From India’s perspective, the quantum of capital inflows has declined, and their composition has also shifted in a less favourable manner. Over the past three years, debt inflows have emerged as the dominant contributor, while equity inflows have seen a sharp decline in their share. In addition, other flows, linked to financial derivatives, including ESOPs, have acted as a drag on overall capital flows.

Chart 3: India’s changing mix of capital flows

Note: Figures for FY26 have been linearly extrapolated basis three quarters of available data.

Source: CIEC and QuantEco Research

Debt flows are often sensitive to interest rates, currency expectations, and sovereign risk perception, and can amplify external vulnerability when global financial conditions tighten. Equity flows are generally more loss-absorbing and durable, but even these are now being reshaped by geopolitical considerations. Investments such as semiconductor plants, battery facilities, data centres, or ports are no longer viewed purely as commercial allocations of capital, but are also assessed through the lens of strategic control. This underscores why hot money and durable capital must now be analysed not only through macro variables, but also through geopolitical filters. The current environment is challenging, as it raises the volatility of cyclical flows while making structural flows more selective and geopolitically conditioned.

Policy Trade-offs
For India, policymakers face a dual challenge. First, ensuring that capital inflows are adequate to finance the CAD on a sustainable basis. Second, nudging the composition of flows towards a mix of durable, equity-oriented capital and longer-tenor debt. A smaller capital account surplus of higher quality is preferable to a larger one of lower quality.

• Structural flows: The policy levers are well known but require relentless execution. This entails a predictable foreign direct investment policy, sectoral caps aligned with strategic objectives, ease of doing business, a dependable taxation regime, and a credible dispute-resolution framework.

• Cyclical flows: The toolkit differs here. It requires deeper and broader capital markets for hedging and efficient risk management, calibrated sterilisation that preserves monetary control, and countercyclical macroprudential measures rather than ad hoc capital controls.

• Debt flows: The objective should be to extend duration and improve composition by encouraging longer-tenor issuances, broadening the rupee-denominated external debt base, and maintaining gradual progress on rupee internationalisation through bilateral trade settlement and offshore payment systems.

This must be accompanied by the maintenance of domestic macroeconomic stability. Rules-based policymaking, avoidance of retrospective changes, and adherence to fiscal discipline remain essential.

For market participants, the implications are structurally clear, even if cyclically noisy.

With global capital flows becoming more selective, a sustained rupee appreciation is difficult to argue for. Two-way volatility is likely as the RBI conserves foreign exchange reserves in an uncertain environment.

Monetary and fiscal credibility can anchor equity and bond markets, with the latter supported in part by index-inclusion dynamics. However, the yield curve may carry a risk premium linked to external financing conditions, while equity flows could remain constrained by relative valuations compared with other emerging markets. Over the medium term, investors are likely to focus on policy efforts aimed at rebuilding a durable foreign direct investment pipeline.

In the post-COVID world, geoeconomics and geopolitics are no longer peripheral risks. They are central variables shaping trade, supply chains, capital flows, and financial stability. Policy credibility will hinge on distinguishing between temporary disruptions and structural fragmentation, between productive resilience and costly economic nationalism, and between transient capital and durable flows in financing the BoP.

1 We have considered the period FY21 until FY27. Of this, FY23 and FY25 reported a BoP deficit. As per market consensus, FY26 and FY27 are expected to report a net BoP deficit.
2 Trend rate is defined as the average over the previous 10-years.
3 Changing Global Linkages: A New Cold War? – IMF Working Paper (Apr 2024) | Gita Gopinath, Pierre-Olivier Gourinchas, Andrea F Presbitero, and Petia Topalova