India faces ‘stiff’ external challenges, global fight for capital: MoF review

New Delhi: India’s resilience to external shocks is being tested by a tougher global fight for capital, with “unsettled” trade ties with the US, the investment boom around artificial intelligence (AI) and a manufacturing push in the developed economies threatening to weigh on inflows, the finance ministry said in its monthly economic review on Thursday.

Like other developing economies, the country faces a “stiff challenge” in drawing capital flows amid external turmoil, while the rupee continues to see pressure in the short-term. The economy has shown it can absorb shocks, the ministry said, but the country cannot afford to lower its guard or rest on its post-pandemic growth laurels.

Economic growth, therefore, has to be “earned every quarter”, the ministry said in its economic review for September, highlighting the challenge for policymakers.

“Our nowcasting measure, unveiled in the Economic Survey earlier this year, anticipates a real GDP growth rate of 7.3% in the fiscal second quarter (July-September),” the ministry said.

This suggests sustained strong momentum from the June quarter's 7.8% growth, “though at a more measured pace”, it added.

India has remained world’s fastest-growing major economy since fiscal year 2022 (FY22), and most analysts expect it to expand 6.8-7.0% this fiscal year.

The ministry expects net foreign direct investment (FDI) inflows to rebound this fiscal year. Between April and July, net FDI rose 38% from a year earlier to $13.4 billion, while gross inflows were at $43.9 billion.

Strong capital inflows, supported by increased banking capital and higher net FDI inflows, have helped the overall balance of payments. Foreign exchange reserves were at $765.9 billion as of 18 September, providing a “substantial buffer against external sector vulnerabilities", and enhancing the resilience of the external sector, the review said.

Fight for capital

With the US-Iran war getting prolonged, the report pointed to global headwinds, citing the crude oil price surge in September following fresh flare-ups in West Asia and a rise in global bond yields.

India’s bond yield has risen at a much slower pace, the ministry said, but the resulting lower risk premium is putting pressure on the rupee. Still, “there is every possibility that, over the medium term, investors would appreciate the fundamental reasons behind the lower risk premium on Indian debt”.

The yield on the 10-year US treasury papers has jumped 52 basis points (bps) over the past one month to 5.32%, while that on the Indian government securities of the same tenor has risen 25 bps to 7.21%.

The ministry identified three short-term pressures on India’s ability to attract capital.

First, trade relations with the US remain unsettled after Washington adopted a law late September empowering the President to impose tariffs of up to 100% on countries buying Russian crude oil.

Second, the global AI investment cycle continues to channel capital across borders. “At the same time, the AI bubble has not begun its inevitable meaningful deflation. The AI story continues to drive capital investment and capital flows across borders,” the report said.

Third, developed economies are competing to secure investments for renewed manufacturing ambitions amid the increasing weaponization of global supply chains.

Resilience is holding

The ministry pointed to several signs on the resilience of the Indian economy. Merchandise and services exports may reach a record $1 trillion this fiscal year, as they have already crossed $400 billion in the first five months of FY27.

“That is a very strong confirmation that India’s trade agreements are providing impetus to India’s exports. It can only get better from here, with more trade agreements on the anvil,” it said.

Both the merchandise and overall trade deficits narrowed in August, helped by a 26.1% jump in goods exports.

Government's timely measures cushioned the country from the impact of the war-related disruptions, it said. “Timely government measures to secure energy supplies and critical inputs, together with the limited pass-through of global energy prices to domestic fuel prices, helped insulate domestic activity from the external shock,” the review said.

High-frequency indicators painted a mixed picture. E-way bill generation and manufacturing PMI growth have slowed, while services activity gained traction in August, driven by stronger new business and employment, it said. Electricity and fuel consumption continued to grow at a decent pace, and bank credit sustained its strong expansion.

The review said domestic price pressures have intensified because of renewed global oil market stress and weather-related volatility. Still, the overall “inflation landscape remains predominantly anchored”, with about 69% of items in the retail price gauge seeing inflation well below the 4% medium-term target.

The ministry, however, flagged emerging pressures in some food commodities and consumer electronics amid the El Niño-related risks and global chip price pressures. It said farm activity was supported by the country's water reserves as monsoon rains were deficient.

The labour market has remained robust, the review said, with rising labour force participation, a moderating unemployment rate and improved hiring.