Why in news?

India has been the world’s fastest-growing major economy, averaging 8.2% GDP growth between 2021 and 2024 — higher than Vietnam, China, and other major economies. The momentum continued in 2025 with growth of 7.4% and 7.8% in the first two quarters.

Yet, this impressive performance has not translated into steady foreign portfolio investment (FPI) inflows. Except for 2023-24, when FPIs invested $25.3 billion, all other recent years saw net outflows — $18.5 billion in 2021-22, $5.1 billion in 2022-23, $14.6 billion in 2024-25, and $2.9 billion in 2025-26 (till September).

This disconnect highlights persistent investor caution despite robust growth.

What’s in Today’s Article?

• Role of Foreign capital in India's growth
• The Foreign Capital Paradox in India
• Why Capital Flows to India Have Declined
• Balance of Payments Challenges for India

Role of Foreign capital in India's growth

• Foreign capital, which includes Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI), has played a significant role in India's economic growth, especially since the economic liberalization of 1991.
• It provides financial resources that the domestic economy may lack, acting as a crucial driver of development.
• Foreign capital supplements domestic savings, finances investment needs, and bridges the gap in capital-scarce sectors.
• FDI has modernised industries, brought in advanced technologies, boosted infrastructure, and created employment opportunities. It has also integrated India into global supply chains and enhanced competitiveness.
• FPI has deepened capital markets and provided liquidity, though with volatility risks.
• Beyond finance, foreign capital strengthens innovation, supports services like IT and e-commerce, and improves balance of payments by financing current account deficits.

The Foreign Capital Paradox in India

• Despite India’s robust GDP growth of 7.8% in early 2025, overseas capital inflows have remained weak.
• Net capital flows fell to $18.3 billion in 2024-25, the lowest since the global financial crisis of 2008-09, and inflows in April-June 2025 were over 40% lower than the same period last year.
  • Net capital flows into India includes foreign investment, commercial borrowings, external assistance and non-resident Indian deposits.
• Balance of payments (BoP) data show net foreign investment plunging from a peak of $80.1 billion in 2020-21 to just $4.5 billion in 2024-25, with minimal FDI ($959 million) and modest FPI inflows ($3.6 billion, largely in debt).
  • BoP records all financial transactions between a country and the rest of the world over a period.
  • It tracks money inflows and outflows from trade in goods and services, investments, and loans involving individuals, companies, and governments.
• Equity markets, however, saw heavy sell-offs.
• Meanwhile, external commercial borrowings rose to $15.8 billion in 2024-25, reversing the outflows of previous years.
• The disconnect between high growth and low foreign capital underscores investor caution about India’s economic prospects.

Why Capital Flows to India Have Declined?

• Impact of Past Investments
  • Much of the FDI that entered India during the last decade, peaking in 2020-21, came from private equity (PE) and venture capital (VC) in sectors like retail, e-commerce, financial services, green energy, healthcare, and real estate.
  • These investors are now exiting to monetise mature positions, leading to reduced net inflows.
• Investor Exits and Monetisation
  • According to industry experts, PE/VC exits were valued at $24 billion in 2022, $29 billion in 2023, and $33 billion in 2024.
  • Nearly 59% of exits in 2024 were through public markets, supported by India’s strong stock valuations.
• Foreign Portfolio Investor (FPI) Behaviour
  • FPIs too have been selling off, but their exits have been offset by bullish domestic investors who sustain attractive market valuations, enabling profitable exits for both FPIs and PE/VC firms.

Balance of Payments Challenges for India

• India’s merchandise trade deficit surged to $287.2 billion in 2024-25, more than triple the 2007-08 level.
• These deficits have so far been offset by strong surpluses in services exports and remittances, keeping current account deficits under $50 billion in most years and financed through steady capital inflows that boosted forex reserves.
• However, risks are rising. U.S. President Trump’s 50% tariffs threaten Indian exports to a $86.5 billion market, while capital inflows remain uncertain, driven more by investor confidence in corporate earnings and valuations than headline GDP growth.
• Recent capital outflows and tariff concerns pushed the rupee to a record low of 88.37 per dollar.
• In response, the current government has cut GST rates to stimulate consumption and earnings and announced a task force for next-generation reforms to improve ease of doing business.