India’s External Sector Under Pressure: The Case for Greater Capital Account Convertibility
US President Donald Trump & India PM Narendra Modi (Image credit X.com, File)
South Asian neighbors and the Global South are watching India’s macroeconomic moves closely; managed well, they could boost resilience, integration, and regional leadership.
By SAHASRANSHU DASH
KATHMANDU, September 8, 2025 — The United States’ decision to impose a 50 per cent tariff on a wide range of Indian exports is more than a bilateral trade dispute—it is a stress test for India’s external sector with implications for the broader South Asian economy. Exports to the US constitute a major source of foreign currency, while remittances—totalling USD 137.7 billion in 2024—remain a lifeline for millions of households. Any major disruption in either could ripple across regional supply chains, reduce employment-linked inflows, and shift trade advantages toward competitors like Bangladesh.
External Pressure, Not Crisis
First, the good news. Despite these headwinds, India is far from a balance-of-payments crisis. Foreign exchange reserves of roughly USD 690 billion cover more than ten months of imports, significantly exceeding short-term external debt obligations. The external debt-to-GDP ratio remains moderate by emerging market standards, and the rupee’s flexible exchange rate provides room to absorb shocks.
Historical context helps explain why India is better positioned than in the past. In 1991, India faced a severe payments crisis, forcing emergency loans from the IMF. Similarly, the 2013 “taper tantrum” exposed emerging markets to sudden capital outflows, but India’s reserves and macroprudential tools helped contain instability. Today, structural inflows from services exports and foreign direct investment provide an additional layer of stability.
Yet vulnerabilities persist. A sharp contraction in export revenues, slowed remittances, or negative portfolio flows could still put pressure on the current account and the rupee. While reserves provide a buffer, they are not a panacea for systemic shocks.
Partial Capital Account Convertibility as a Stabiliser
India’s relative insulation from external volatility owes much to its partial capital account openness under the Foreign Exchange Management Act. Partial convertibility, which allows controlled flows of capital in and out of the country, has acted as an effective stabiliser during shocks. Individuals face annual outward remittance limits under the Liberalised Remittance Scheme, corporates must comply with reporting and hedging requirements, and portfolio investors navigate quantitative caps and route-based entry conditions.
This framework has proven stabilising during periods of stress. During the 2008 global financial crisis and the 2013 “taper tantrum,” India avoided severe capital flight thanks to constrained cross-border flows, ample reserves, and macroprudential tools, allowing policymakers to focus on domestic liquidity and credit support. Yet, rising protectionism worldwide raises a pressing question: are these arrangements sufficient to withstand simultaneous disruptions in trade and remittances, particularly when regional economies are also exposed to similar shocks?
Short-Term Measures to Cushion Shocks
Partial convertibility, if used proactively, can serve as an immediate buffer. The Reserve Bank of India has tools to intervene in foreign exchange markets without threatening reserve adequacy. Historical instruments such as the 2013 swap facility for non-resident deposits, which attracted over USD 30 billion, could be revived.
Other tactical measures include incentivising NRI deposits through temporary rate adjustments, issuing diaspora bonds, and expanding access for global investors in government securities. Digital corridors for remittance flows and rupee-based trade settlement can reduce transaction costs and slow the outflow of foreign currency. While these measures provide breathing room, they remain tactical responses rather than a substitute for a long-term strategic framework.
Lessons from Global Comparisons
Singapore and South Korea offer useful insights for India. Singapore maintains one of the most open financial systems globally but stabilises through a transparent, exchange-rate-centred monetary policy and deep domestic savings mobilised through institutions like the Central Provident Fund and sovereign wealth funds. South Korea, while also maintaining an open capital account, uses macroprudential safeguards such as levies on short-term foreign currency liabilities and derivative position limits that can be activated during stress without reversing openness.
Emerging markets like Chile demonstrate another model: gradual liberalisation anchored by strong fiscal discipline and flexible exchange rate policies. Across all cases, the key lesson is clear: full capital account liberalisation can coexist with stability, provided markets are deep and policy instruments are well designed. India’s challenge lies in adapting these lessons to its domestic context.
The Way Ahead
India’s path towards full capital account convertibility must be gradual, sequenced, and conditional. In the first phase, spanning 2025–2027, the focus should be on institutional readiness. Macroeconomic thresholds for fiscal deficit, inflation, and banking sector resilience need to be codified clearly, while domestic bond and derivatives markets are deepened and hedging facilities expanded. Outward investment limits for residents can be relaxed cautiously under strict compliance frameworks. Simultaneously, efforts to promote rupee invoicing in trade settlements should continue, reducing dependence on the dollar and building a foundation for a more resilient external sector.
During the second phase, from 2028 to 2031, capital account openness can be widened while retaining macroprudential “brakes.” Full portfolio flows should be allowed, residual barriers gradually removed, and onshore non-deliverable forward markets developed. Countercyclical instruments will remain crucial to moderate excessive short-term inflows, ensuring that shocks can be managed without reversing openness. Each phase would be accompanied by calibrated safeguards, ensuring that external shocks are absorbed without destabilising the economy.
Ultimately, by 2032–2035, conditions may support full de jure convertibility. Quantitative limits would give way to price-based, countercyclical instruments, enabling residents and non-residents to move capital freely in both directions. Achieving this stage will require deep and liquid financial markets, robust domestic savings mechanisms, comprehensive hedging facilities, and contingency arrangements such as bilateral swap lines and precautionary credit lines.
Carefully sequenced liberalisation, accompanied by robust safeguards, will allow India to integrate fully with global markets without compromising stability.
From Vulnerability to Strategic Resilience
The immediate tariff and remittance shocks underline a broader structural risk: overreliance on a narrow set of external flows. Addressing this challenge demands both tactical interventions and a long-term strategic framework. Sequenced, institutionally supported capital account liberalisation can reduce dependence on trade and remittances while positioning India to engage with global financial markets on stronger terms.
Many in the Global South as well as key South Asian allies—including Nepal and Sri Lanka—are closely observing India’s approach towards macroeconomic stability. How India moves forward in the months and years to come will signal whether it emerges as a resilient regional rule-shaper or a reactive follower in the evolving financial system. Managed carefully, this transition can strengthen India’s external resilience, economic integration and leadership role across South Asia for the decade ahead.
(This is an opinion piece, and views expressed are those of the author only)
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