How India Went From Agile to Fragile | Indian Economy In Currency Crisis...Again

Added: 2026-06-02

[00:00:00]Back in April, I had posted a video on how the Indian economy might look fine on the surface, but extreme pressures are building underneath. On growth, on inflation, on fiscal, on external balances. It's like the duck syndrome.

[00:00:13]The duck looks calm and composed above water, but is furiously pedaling below, struggling to cope. A month or so back, to the casual person, allow me to rephrase, to the casual voter, India was dealing with the Iran war with great flair. No petrol and diesel price hikes, no appeals to cut down activity, ministries reassuring us every second day that all is well. And all was well.

[00:00:39]That is, until the people of West Bengal, Assam, Tamil Nadu, Kerala, and Puducherry decided on their next government. Then Prime Minister Modi took the mic and did the ultimate mic drop. Don't buy gold, don't go abroad, take public transport, work from home.

[00:00:56]We are hiking fuel prices, haven't you heard? We are in a crisis.

[00:01:00]And so, just like that, we went from an economy that was doing great to desh ko bachao.

[00:01:07]Since then, the government has swung into emergency mode. Government departments are tightening their belts.

[00:01:12]Petrol and diesel prices have been hiked multiple times. The government has more than doubled customs duties on gold and silver. It is also introduced regulations to make it difficult for companies to import them. And media chatter suggests that more measures are in the pipeline.

[00:01:29]But here's the question.

[00:01:31]Before the crisis started back in February, the RBI governor had called India's economic condition better than Goldilocks. Goldilocks is a common term used in market economics to describe a situation of stable growth, low inflation, basically fairy tale perfect economic conditions.

[00:01:50]And yet, all it took was two months of a Gulf War, and Goldilocks is now having a full-blown panic attack.

[00:01:58]Every second day, the rupee is at the risk of tanking.

[00:02:02]Foreign investors are fleeing, and the government and the RBI are talking of measures that were last in play back in 2013 during the taper tantrum crisis when the mere talk of the US withdrawing cheap money triggered a meltdown in emerging market currencies, and India was known as one among the fragile five.

[00:02:23]So, how did the cookie crumble so fast?

[00:02:26]Is this simply a consequence of the Iran war, or is something more afoot with India's macro story? Hello and welcome to the Bond Economist, your one-stop destination for professional advice on the economy. My name is Aurodeep Nandi, and today we unpack why our seemingly prosperous economy suddenly finds itself in a crisis.

[00:02:47]Specifically, we cover three issues.

[00:02:49]One, what's exactly driving India's currency crisis right now? Two, why this crisis was, in fact, a long time coming.

[00:02:58]And three, what's the way forward? As always, if you like this kind of content, please hit like and subscribe.

[00:03:06]And if you'd like to support me, feel free to scan the QR code or use the Super Thanks button below. First things first, let's cover the basics.

[00:03:14]Let's really define what the emergency is.

[00:03:18]>> [music] [music] >> Now, the general narrative in people's minds is that we've been appealed to not travel abroad or buy gold or to work from home because the Iran war has amped up prices of crude oil and other industrial raw materials. And so, by cutting our import demand, the nation will be demanding lesser dollars, which in turn will improve the rupee strength.

[00:03:46]And this is sort of right, but it's not the whole picture.

[00:03:50]Look, there are broadly two sources through which dollars come in and out of the country. One that Prime Minister referred to when he talked about these curves is the current account. The current account broadly comprises of three components.

[00:04:05]The exports minus imports of goods, exports minus imports of services, and net remittances from Indians living abroad.

[00:04:14]And this number is generally negative.

[00:04:16]So, on a net basis, we always end up spending more dollars on imports than what we earn from exports and remittances. Hence, you will see economists call it current account deficit because in India's case, it's generally always negative or in deficit.

[00:04:34]And look, that's not necessarily a bad thing. A current account deficit is natural for a growing emerging market because imports tend to pick up when growth improves.

[00:04:46]In fact, a lot of us economists routinely monitor the non-oil, non-gold import growth every month as a barometer of how strong or weak domestic demand is.

[00:04:57]But, the question is, at what point does the current account deficit become too wide?

[00:05:04]Is it the case that we are being told to trim imports now because the deficit is already too wide?

[00:05:10]Well, not really.

[00:05:12]See, before the Iran war, it was tracking less than 1% of GDP, way, way lower than historical levels. And this year, despite the Iran war, despite crude oil prices going through the roof, despite the country's apparent obsession with gold, economists are placing the current account deficit between 2 to 3% of GDP. To put that into context, India typically starts panicking when the current account deficit reaches 3 to 4% of GDP and above. So, by historical standards, we are still low.

[00:05:45]But, what explains current account deficit being under control despite the Iran war? After all, we do import a lot and despite all the Make in India bravado, our goods exports haven't really picked up much. So, why isn't the current account deficit blowing up?

[00:06:02]Because we have two very important buffers. One is strong and stable flows of remittances from the Indian community abroad. And two, very crucially, India's services exports. Not just providing IT services, but also doing back-end operations for some of the world's largest companies in what's known as global capability centers. So, India's situation right now is a bit like those exams where you may do really bad in most subjects, but you manage to get very good marks in a couple of papers.

[00:06:34]And so, your overall score remains respectable.

[00:06:38]Which brings us to the question, if our current account deficit hasn't yet become that high despite the war, why is the government telling us to cut down on things like gold and foreign travel?

[00:06:50]Well, this brings us to the second channel through which dollars enter and exit the country, and that is India's capital account.

[00:06:59]>> [music] >> The capital account is broadly speaking the dollars we gain or lose on things like investments and loans. There is FDI or foreign direct investment, so foreign companies taking ownership stakes in Indian companies or setting up their operations here versus what Indian companies are doing with the rest of the world.

[00:07:23]There is FII, foreign institutional investment, so this is foreigners investing in our stock and bond markets, again on a net basis. There's deposits from NRIs, there's foreign currency loans that Indian companies take.

[00:07:37]There are other components too, but broadly these are the main ones.

[00:07:41]And as you can appreciate, these flows are very different to buying and selling of goods and services that's part of the current account.

[00:07:50]Now, how have things been working out for India so far?

[00:07:54]Well, we run a deficit on the current account because of our high imports relative to exports and remittances.

[00:08:01]But, not to worry. Just like dollars are going out of the country, dollars are also coming in through the capital account because India is traditionally considered an attractive destination for foreign investment. So, once we add the negative current account deficit and the positive capital account surplus, the net value, also known as balance of payments, generally is in surplus or in a small deficit. Which means that on the whole, the country manages to earn as much or a little more dollars than it loses.

[00:08:39]But, what happens when this charming equilibrium gets disturbed? What happens if on one hand we keep spending dollars on the current account, but on the other hand enough dollars aren't coming back from the capital account?

[00:08:55]Well, then balance of payments becomes massively negative. That means there is a lot of demand, but less supply of dollars in the economy. Naturally, the demand for dollars shoot up and the rupee depreciates. And this is exactly what's happening to India right now.

[00:09:15]>> [music] [music] >> Well, the problem predates the Iran war.

[00:09:25]Those with hot money, the foreign institutional investors, who can easily invest and withdraw money out of our stock and bond markets, they have been pulling out of India.

[00:09:37]India has been widely perceived as an overvalued market with domestic investors keeping the momentum up with SIPs, which has given a good off-ramp for foreign money to exit.

[00:09:49]Meanwhile, the more stable foreign direct investment FDI on a net basis is at multi-year lows. Why?

[00:09:59]Well, interestingly, we are getting FDI inflows, but the problem is that there has been massive outflows of FDI of late. That means A, foreign companies are repatriating money back from India.

[00:10:13]It could be the case that they cashed in their investments during IPOs and exited India on the high.

[00:10:20]And B, Indian companies are increasingly interested in investing abroad. By the way, there's always been a shady element to uh India's FDI story.

[00:10:31]Sometimes Indian companies masquerade as foreign firms registered in Mauritius or Singapore or Cayman Islands, and they use that as a more tax-efficient route to funnel funds in and out of their Indian operations. In fact, one of the things the RBI is reported to be doing right now is increasing the scrutiny of this kind of outbound FDI.

[00:10:53]But regardless, it is interesting that both Indian and foreign companies are looking to park their money abroad at a time when the government is struggling to get private investment to pick up in the country.

[00:11:10]Which essentially means their implicit downvote for the Indian economy.

[00:11:16]So, where exactly is India messing up?

[00:11:19]>> [music] >> Look, we live in a world where three tectonic plates are shifting as we speak. One, the era of low interest rates in developed economies seems to be over. At the end of 2021, US 10-year yield was around 1 and 1/2%.

[00:11:40]But with higher inflation and increasing fiscal pressures among other factors in the US, it's now tracking around 4 and 1/2%. So, the difference between Indian and US yields is pretty low right now.

[00:11:53]Why does this matter?

[00:11:55]So, when the US yield was 1 and 1/2%, global investors could borrow cheaply abroad, hedge the currency risk, and still make money by investing in Indian debt at around 6 and 1/2 to 7%.

[00:12:07]But, if you now need to borrow in the US at not 1 and 1/2, but 4 and 1/2%, and then you add hedging costs, then suddenly parking it for just 7% in India doesn't feel all that exciting. And also, why take on the risk of investing in an emerging market like India, braving rupee depreciation, when you can instead get 4 and 1/2% risk-free from a US bond?

[00:12:32]So, that easy route through which India was receiving cheap foreign funds is now at risk.

[00:12:39]Second tectonic plate in motion, AI.

[00:12:42]In a world where some countries are making frontier models, and other countries are dominating the chip production ecosystem, India finds itself sliding down the AI value chain.

[00:12:54]It is perceived by investors as A, a potential a data center location, and B, an adapter of AI, rather than a cutting-edge innovator of it.

[00:13:04]>> Go to an enterprise, understand the business of enterprise, understand the working of that enterprise, and provide that service using AI applications.

[00:13:11]That's going to be the biggest factor of success.

[00:13:14]>> Then there is the concern that with AI progressively replacing routine jobs, what would the future of outsourcing look like for India that depends so much on its services exports?

[00:13:27]So, not only is foreign capital getting more expensive, India is also struggling to cash in on the AI excitement of investors.

[00:13:36]And three, once upon a time we lived in a world that was far more globalized and where being the lowest cost destination was all that mattered. A model that for many years allowed China to turbocharge its way to becoming the world's factory.

[00:13:52]But that's no longer the case. We now live in a world where chains are always in a state of tension.

[00:13:59]Countries are turning protectionist.

[00:14:02]Donald Trump may say that he loves Modi, but what he ultimately wants is Indian companies setting up factories in the US.

[00:14:11]Countries are also routinely weaponizing their supply chains.

[00:14:14]Like recently, to retaliate against the US, China pulled the plug on the rare earth minerals that it supplies, which go into electronic devices.

[00:14:25]The global shortage ended up bringing Indian auto companies down on their knees. So, in this new world, India has been struggling to get a foothold. Even the China plus one play, where the theory for the past decade or so has been that trade tensions between the US and China should lead global manufacturers to shift factories to the rest of Asia, well, it's been a mixed success for India. Yes, we are assembling a lot of iPhones and some other electronic devices, and yes, we are trying to manufacture semiconductors, but it's a slow start and we are way, way behind other countries in terms of technology.

[00:15:07]Our share in global goods exports has remained flat. Our share of global FDI flows isn't shooting up. In fact, forget replacing China, we have become so reliant on Chinese imports ourselves that India's trade deficit with China is massive right now.

[00:15:28]So, all in all this is a much more hostile world for India to attract foreign capital.

[00:15:34]Which brings us to the question what are the options for India?

[00:15:39]>> [music] >> There are three options on the table.

[00:15:47]Either you do what the government is trying to do right now. You accept the fact that capital account has a problem, but you don't want the rupee to depreciate too much. So, you try to trim your current account deficit. Which happens when you buy lesser oil and gold and when you don't go on foreign trips and so on.

[00:16:06]But remember, when you restrict imports there is a collateral damage on growth.

[00:16:11]For instance, if you cut gold imports, the livelihoods of thousands of people in the gems and jewelry business stands jeopardized.

[00:16:20]If you ask people to work from home to save on India's crude oil imports, well, then the livelihoods of auto and cab drivers get hit. So, another way of reframing the debate is that India can't afford to keep running at its current growth rate, so you are effectively applying some brakes to it. So, that's option number one.

[00:16:41]Second option, you protect growth. Ergo, current account deficit remains broadly where it is.

[00:16:48]But you're also not getting enough capital flows.

[00:16:51]So, there is a large leakage of dollars happening.

[00:16:55]So, then you have to accept that the currency will be under huge depreciating pressure.

[00:17:02]Then the RBI has a choice.

[00:17:04]It can choose to drain the forex reserves by selling dollars and buying rupees in the process increasing the relative value of the rupee and basically then defending the currency.

[00:17:15]But as we've covered in the past on this channel, there are costs involved in this strategy. If RBI loses too much reserves, then investor confidence in the currency goes down, and the rupee depreciates regardless.

[00:17:30]Plus, the act of withdrawing rupees while selling the dollars raises domestic interest rates, which then hits growth.

[00:17:40]So, then you have to find a way to get liquidity back into the system.

[00:17:46]So, this is not a straightforward option. I'll leave links in the description to my previous videos where I talk about these in much more detail.

[00:17:54]Or alternatively, you let the currency depreciate.

[00:17:57]At some level of a weaker rupee, imports will get too expensive, exports will get competitive, and the current account deficit will shrink to match the capital account surplus. And so, you let the currency play the role of an economic stabilizer of sorts.

[00:18:15]So, we've discussed two broad options so far. One, you take active measures to trim your current account deficit to ease the pressure on the rupee, but that comes at the cost of growth.

[00:18:26]Or two, you let the current account be as it is, but then the full pressure falls on the currency.

[00:18:34]Either let it fall to an equilibrium level, or use up your forex reserves to apply brakes on the depreciation.

[00:18:42]And then there's option number three.

[00:18:44]You don't want the rupee to depreciate.

[00:18:47]You don't want to compromise on your current account deficit. So, you find ways to attract capital.

[00:18:54]Now, in the short term, you can't suddenly boost FDI or FII flows. But, what you can do is what India did in past crisis. Convince NRIs to deposit money in local banks. So, Indian banks will have to offer higher interest rates to NRIs, especially when global interest rates are already elevated. And we won't get into the mechanics of the scheme in this video, but know that to convince banks to participate, RBI also needs to bear some burden. So again, there are pros and cons to this.

[00:19:28]But look, these are all temporary solutions.

[00:19:30]What's the more durable solution to this problem?

[00:19:35]>> [music] >> Recently, I came across this op-ed in the Times of India by someone called Vineet Relia.

[00:19:46]And Vineet Relia has a unique job. He's a crisis manager for corporates, particularly foreign companies operating in India.

[00:19:54]From what I could gather, he's the fixer they call when something goes horribly wrong. So in this op-ed, and I'll leave the link in the description, he talks of his experience of the kind of problems that he solves. And honestly, it feels like the business version of a horror story. For instance, he talks of how a German company was having some dispute with their joint venture partner in India, a family business.

[00:20:18]And evidently, as civil disputes take a long time to resolve, the Indian business went ahead and filed a dodgy criminal FIR against the senior executive that the German company had sent to negotiate.

[00:20:31]And that guy found himself behind bars for a month. Mr. Relia also talks about how one time Korean executives from an auto parts conglomerate noticed malpractices happening in their Haryana factory, but couldn't access it because the local mafia was threatening them.

[00:20:49]He also talks about this case of the COO of a company who was jailed for months because his company was disputing a service tax order by the government.

[00:20:59]Now, he has, of course, anonymized all of this, so it's up to you how much you think this is accurate or an exaggeration, but the point is that at a time when India isn't getting enough FDI and in a world where foreign capital has become expensive and has become picky, India can't afford to be such a complicated place to do business. You can't be saying that please come and invest in India, but if you have a problem with our local administration, with the local mafia, with our tax departments, with our courts, then too bad. You're on your own.

[00:21:33]Now, it's not like the government doesn't know this. In fact, it had recently restarted the reform engine. It brought in Jan Vishwas bills to cut red tape and decriminalize offenses. It introduced labor reforms.

[00:21:49]It introduced a new nuclear law to help access cleaner power. It cut GST rates.

[00:21:56]It finally did something about the epidemic of quality control orders, random orders that were being passed by departments at the behest of large domestic companies to make it difficult for MSMEs to import the raw material they needed and instead forcing them to rely on their less competitive products.

[00:22:15]But the timing seems to be bad because just when they were introduced, all of this by the way, end of last year, the Iran war broke out a few months later.

[00:22:26]But here's the thing. These should have been rolled out much earlier because such reforms take time to create impact on the ground.

[00:22:35]So, who knows? If this was done a few years back when the China plus one theme was really gaining momentum, maybe we could have avoided this existential FDI slump right now.

[00:22:47]The point is that currently India is lacking a strong investment theme for foreign investors.

[00:22:54]The days of saying that look, we have a young population, we have such a huge consumer market, we have land, uh we have cheap we can duplicate goods and services quickly. Of course, you know, we are such a great destination for investment.

[00:23:10]Those days are over. The new world demands tech leadership. It demands research and development from our companies. It demands investment in ecosystems. It demands a reliable institutional framework.

[00:23:24]Demands predictable regulations by our government.

[00:23:28]It demands lesser frictions of doing business on the ground.

[00:23:34]And sure, who knows?

[00:23:36]Maybe the war gets over soon. Maybe sometime later oil prices come down and the current account deficit will shrink and the rupee will stabilize and a lot of these issues may again feel abstract.

[00:23:48]But without this course correction, India will only keep stumbling from one crisis to another.

[00:23:54]For more such insights, like, share, and subscribe to The Bond Economist.

[00:24:01]>> [music]