Understanding India's external account challenge | Number Theory

While India has always had a merchandise trade deficit, things have worsened in the more recent past.

“The West Asia crisis is not a foreign policy concern that occasionally bleeds into economic planning but a live balance-of-payments stress test with direct consequences for inflation, CAD (current account deficit) and exchange rate,” Chief Economic Advisor (CEA) V Anantha Nageswaran said on Tuesday at a CII event. The CEA’s comments come days after the Prime Minister appealed to Indians to judiciously use petrol-diesel and stop buying gold and traveling abroad to help the economy mitigate the consequences of the ongoing war in West Asia.

A cargo ship sailing into a port amid the West Asia conflict. (AFP)

These pages discussed on Tuesday how the IMF expects India’s current account deficit to increase for four consecutive years up to 2027-28 and some demand deflation might be absolutely necessary to prevent this from snowballing into a larger economic crisis. This general argument aside, what exactly are the dynamics of India’s current account and how effective are the Prime Minister’s suggestions likely to be? This is best understood by disaggregating India’s current account balance and the overall external balance problem.

Understanding India's external account challenge

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  The headline current account number is the Invisibles surplus trying to balance Merchandise deficit

  The current account is essentially the sum of the balance on the merchandise trade account and the invisibles account. The former is the difference between goods exports and imports. India runs a deficit here. The latter is the sum of services trade, transfers and foreign incomes. India runs a surplus in the first two and a deficit in the third. While India has always had a merchandise trade deficit, things have worsened in the more recent past. The overall current account balance situation would have been much worse had the invisibles surplus not improved and compensated for the merchandise account headwinds. While we only have GDP data until the quarter ending December 2025 to look at the current account balance as a share of GDP, the current account breakdown for the quarter ending March 2026 does not suggest a drastic change in the picture as overall, the merchandise and invisibles accounts show a change of no more than 10% of their December 2025 values.
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  A breakdown of the merchandise trade balance shows the importance of gold imports

  The argument is best explained by numbers. India’s merchandise trade deficit in the quarter ending March 2026 was $82.4 billion. Because India depends on imports for its energy requirements, there is merit in looking at the trade deficit excluding this head. To be sure, India also exports petroleum products, so an appropriate measure of the trade deficit excluding energy will be taking out both petroleum (POL) imports and exports. The non-POL trade deficit in March 2026 was $56.2 billion, just about two-thirds of the overall merchandise trade deficit. If gold and silver imports were excluded from total merchandise imports (gold imports accounted for 85% of this sub-head), the non-POL deficit would fall to just $29.4 billion. Theoretically, if gold imports were to come down to zero, the current account would get a huge breather.
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  Surplus in Invisibles is software exports and remittances more than compensating for everything else

  RBI data breaks down the Invisibles component of the current account into various useful heads. It includes an eight-fold disaggregation of services, transfers and incomes. India runs a surplus in the services category and transfers and a deficit in incomes. The data shows that things such as travel and transportation should not really matter as long as software and other business exports and remittances (which is what transfers are) continue to do well. Another number can help put this in perspective. In the quarter ending December 2025, the latest period for which data is available, India’s software export trade surplus alone was almost half of India’s merchandise trade deficit. Seen another way, this also underlines India’s external balance’s vulnerability to a large AI shock to the software industry.
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  The elephant in the room is the capital account

  This makes it important to ask about the more important part of the puzzle: the dynamics of India’s capital account which can potentially cushion current account headwinds via routes such as FDI and portfolio investments. The situation, a long-term analysis of India’s external account data shows, is one of concern. In the past 103 quarters beginning June 2000, only twice have India’s net FDI and portfolio investments been negative simultaneously. Both of these quarters are in the recent past: December 2024 and December 2025. Had foreign capital been more willing to invest in India, the current account pain could have been managed. The reasons for the lack of foreign investor appetite in India draw tailwinds from the ongoing geopolitical disturbance, but they also merit introspection on whether this reflects India’s long-term appeal losing its earlier sheen.