The two flows are interlinked.
Having failed to emulate East Asia’s success with manufacturing exports, India pays for its chronic trade shortfall by writing IOUs to global investors. As Kotak Institutional Equities in Mumbai noted in a recent report, a combination of high current deficits and large capital surpluses has historically sustained India’s external accounts. But that model of financing was weakening long before the effective closure of the Strait of Hormuz.
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For the past six years, venture capital and private equity firms have been aggressively taking profits on their investments in e-commerce, digital payments and other startups. Multinationals like Hyundai Motor Co. and LG Electronics Inc. also took advantage of India’s frothy equity valuations to offload shares in their local units. More than 60% of the IPO fundraising last year ended up giving exits to firms’ original sponsors. In other words, Indian households and institutions bought the IOUs, and foreigners took out dollars.
Meanwhile, fresh ideas — especially around artificial intelligence — are nowhere near what firms in China, South Korea and Taiwan are offering investors. The mercantilist capitalist class that straddles India’s economy because of its proximity to political power can’t think beyond data centers, which will merely channel cheap solar energy into running AI models. The tokens they mint at home will power Western coding agents like Claude and Codex, eroding the pricing power of domestic outsourcing companies. While the Korean semiconductor industry is in the middle of an unprecedented wage boom, six million programmers in India are facing a funk.
The idea deficit is showing up in the balance of payments, too. What used to be $56 billion net direct investment by foreigners in the fiscal year 2020 fell to just $29 billion between April and December, the first nine months of the last financial year. Even this trickle is leaving as local firms deploy more capital abroad, so net net there is virtually no foreign direct investment to create jobs for the world’s largest youth population.
The logjam won’t clear once oil starts flowing freely again out of the Middle East chokepoint. Nor is foreign fund managers’ selling in public markets — almost $32 billion over the past year — going to cease overnight.
While Brazil’s exports are booming thanks to high commodity prices, and South Korea and Taiwan have a lock on the hardware of AI via chip foundries and high-end memory, India lacks a comparable structural hedge. Analysts’ expectations of corporate earnings growth are already trailing India’s emerging-market rivals, and they may face further downward revisions now that New Delhi has finally allowed state-owned oil refiners to raise pump prices to reduce their losses.
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Should supply-chain disruptions last nine months, local firms would see profit margins compress by 200 basis points across 34 sectors, according to CRISIL, an affiliate of S&P Global Inc. Given the risks, it isn’t just the overseas investors skirting India. Social-media financial influencers — or finfluencers — are luring local households to park their wealth in overseas stocks and funds to chase better returns.
So far, the brunt of India’s capital shortage has been borne by the rupee, the worst-performing Asian currency over the past two years. In recent months, the exchange rate has come dangerously close to the psychologically important level of 100 to the dollar. Reserve Bank of India Governor Sanjay Malhotra says the rupee may now be undervalued. But why should the market believe him?
The factors driving India’s balance of payments into a rare three-year deficit — tight global financial conditions, tech-dominated growth, and high oil prices — are beyond the influence of local policymakers, according to ANZ Group Holdings Ltd.
What the central bank can do, however, is to raise interest rates preemptively. The RBI will stay on hold at its June 5 policy meeting, according to a Bloomberg survey, after having cut rates by 125 basis points since Malhotra took over in December 2024. However, as I wrote earlier this month, the time to avoid a blunt tool like rate hikes may have passed. Without a couple of quick increases, the “market perception that domestic policies remain unaligned with tight global financial conditions will continue to grow,” ANZ economists Dhiraj Nim and Sanjay Mathur noted this week.
While stabilizing the currency may help contain the current crisis, India’s ability to attract global capital will remain muted. Take the auto industry. Big investments are expected from carmakers if only they can shake off a near-complete dependence on China for electric-vehicle battery tech — a vulnerability that shows little sign of abating. Meanwhile, local entrepreneurs are more interested in masquerading exploitative gig work as tech innovation. The big news from the startup world this week is CarryMen, a recently launched service for New Delhi shoppers — they can pay someone as little as $1 to carry their bags around.
When it eventually happens, the reopening of the Strait of Hormuz will provide an easy excuse for complacency. But refueling the engine is pointless if young college graduates continue to get stranded in agriculture, construction, and retail, the least promising sectors from the perspective of productivity and wages. Without a radical injection of fresh ideas, India’s economic machine will keep running on empty.