India's Forex Fortress: The Silent Threat of Outward FDI Drain
India's foreign exchange reserves stood at an impressive $686 billion at the beginning of 2026, a figure often cited as evidence of the economy's external strength and resilience. This remarkable accumulation represents a dramatic transformation from the 1991 crisis when reserves plummeted to barely $1 billion, forcing the Reserve Bank of India to pledge gold with the Bank of England to secure foreign currency loans. That pivotal moment triggered India's economic reforms and opened the doors to foreign investment, setting the stage for decades of growth.
The Legacy of Past Crises
The traumatic experiences of 1991 and the 2013 taper tantrum have left an indelible mark on India's economic policy framework. Building and maintaining adequate reserves has become an integral component of the RBI's strategic approach, with each episode of market volatility reinforcing the central bank's determination to accumulate reserve assets. By the end of 2025, India's reserves could finance approximately 11 months of imports, far exceeding the three-month benchmark recommended for emerging economies.
However, the pattern of reserve accumulation has undergone a significant shift in recent years. While India consistently ranks among the world's top five countries for forex reserves, the annual change in reserves has turned negative three times in the last four years, including the current period. This represents a notable departure from historical trends, as such declines previously occurred only during major crises like the 2008-09 global financial crisis or periods of high current account deficits.
Changing Dynamics of Reserve Accumulation
To understand this shift, it's essential to examine how forex reserves are derived from the international balance of payments framework. Transactions between India and the rest of the world are divided into the current account and capital account. India typically runs a current account deficit (imports exceeding exports) alongside a surplus on the capital account (receiving more capital than it sends abroad). The difference between these two account balances determines whether reserves increase or decrease.
Reserves grow when dollar inflows arrive through exports, remittances, foreign investment, overseas loans, and NRI deposits. Conversely, reserves diminish when dollars flow out due to imports, foreign capital outflows, or repayment of overseas loans. Historically, strong foreign capital inflows drove reserve accumulation, while significant outflows triggered declines.
The Emerging Challenge: Outward FDI Surge
A detailed analysis of balance of payments data reveals two concerning trends that explain the recent pressure on reserves. First, there has been a sharp increase in repatriation of foreign direct investment from India, with amounts jumping from approximately $18 billion before the pandemic to $44 billion in 2023-24 and $51 billion in 2024-25. Simultaneously, gross FDI inflows have remained relatively stable, causing net FDI in India to plummet dramatically.
Second, outward FDI by Indian entities has grown rapidly, more than doubling from $13 billion in 2019-20 to $28 billion in 2024-25. RBI reports indicate that most of this outward-bound FDI has flowed to tax havens like Singapore, Mauritius, and the UAE. Media reports suggest that corporations, high-net-worth individuals, and family offices are increasingly looking beyond India's borders, seeking destinations with more stable regulations and favorable investment environments.
Vulnerability in Reserve Composition
The unprecedented events of 2025 have demonstrated that foreign capital inflows, a crucial source of reserve accretion, cannot be taken for granted. While foreign portfolio investment has always been considered volatile "hot money," the rise in outward-bound FDI represents a new and worrying phenomenon. This development serves as a sobering reminder that India's reserves were not "earned" through trade surpluses but rather represent borrowed capital that foreign investors can withdraw at will.
This contrasts sharply with countries like China, Japan, or the Asian tigers, which built most of their reserves from export revenues. The source of reserve accumulation matters significantly, especially in today's challenging international environment. Dependence on foreign capital flows makes India vulnerable to shifts in market sentiment, potentially triggering a vicious cycle where reserve drawdowns to stabilize the rupee worsen sentiment and accelerate capital outflows.
Policy Responses and Strategic Shifts
The RBI has adopted several measures to address these challenges. The central bank has cut the policy repo rate by 1.25 percentage points, reduced the cash reserve ratio by 1 percentage point, and infused rupee liquidity through rupee-dollar swaps. These monetary easing measures have lowered domestic capital costs while easing norms for external commercial borrowing to enable access to low-cost overseas funding.
In reserve management, the RBI has implemented two significant shifts. First, like other emerging economy central banks, it has been increasing gold holdings to diversify away from the US dollar. Gold now accounts for 16% of total reserve value, up from 6% in January 2022, with 126 tonnes added during this period. This strategy hedges against currency volatility and captures valuation gains from rising gold prices.
Second, the extent of RBI intervention in forex markets has decreased substantially compared to 2024. Between June and December 2024, the RBI sold a net $36 billion to stabilize the rupee—a policy that eroded reserves without preventing the currency's decline. In 2025, the approach shifted toward allowing gradual rupee depreciation with periodic interventions aimed primarily at controlling volatility.
The Fiscal Policy Imperative
The upcoming union budget presents a crucial platform for the government to announce FDI-friendly measures. Removing hurdles to doing business in India represents an obvious starting point for two key reasons. First, foreign direct investment typically follows or complements domestic investment, meaning FDI will hesitate if domestic investors remain cautious. Second, since most FDI operations aim to serve both domestic and export markets, creating an attractive investment environment benefits all investors.
The finance minister has already hinted at possible customs reforms in the budget. Rationalizing customs rules along the lines of the goods and services tax overhaul could prove transformative, with reducing duty slabs and eliminating duty inversion benefiting both domestic and foreign businesses. Industry bodies like the Confederation of Indian Industry have long advocated for a single-window clearance system for FDI along with time-bound approvals for large investment projects.
India's regulatory complexity and bureaucratic red tape present significant challenges for multinational corporations accustomed to quick approvals and stable regulatory environments. Recent judicial developments, such as the Supreme Court making Tiger Global liable for paying capital gains tax retrospectively, represent the kind of rulings that could make foreign investors increasingly wary.
Global Competition for Capital
Attracting investment has become an ongoing process requiring continuous adaptation to changing conditions, as demonstrated by emerging Asian economies in 2025. Vietnam and Indonesia modified investment rules to facilitate foreign investor entry, operation, and market access. China introduced a new customs system in December allowing duty-free foreign inputs to enter Hainan province before being sold domestically with at least 30% value addition—an innovative approach that maintains foreign capital flows while boosting activity in less-developed regions and increasing domestic consumption.
Thirty years ago, building reserves was critical to protect against balance of payments disturbances. Today, having accumulated substantial reserves, India can afford to focus more strategically on the sources of reserve accretion. Rather than viewing reserves as the passive outcome of current and capital account transactions, policy should proactively target foreign inflows that are stable, sustainable, and less prone to sudden reversals. The silent drain of outward FDI represents both a challenge and an opportunity for India to refine its economic strategy in an increasingly competitive global landscape.
