India's net foreign direct investment (FDI) rebounded to $7.7 billion in the first two months of the current financial year (FY26), signaling renewed investor confidence in the economy. However, portfolio flows have fallen short of fully financing the current account deficit (CAD), raising concerns about external sector stability, according to the Reserve Bank of India (RBI) data.
FDI Recovery and Trends
The net FDI inflow of $7.7 billion in April-May 2025 marks a significant improvement from the same period last year, when net inflows were $5.2 billion. This represents a growth of nearly 48%, driven by higher gross inflows and lower repatriation. The rebound comes after a period of subdued FDI in FY25, where net inflows had declined to $26.2 billion from $36.7 billion in FY24. The improvement is attributed to policy measures to attract foreign investment, including production-linked incentives and ease of doing business reforms.
Gross FDI inflows during April-May stood at $11.4 billion, up from $8.9 billion a year ago. Sectors such as services, computer software and hardware, trading, and construction received major investments. Singapore, Mauritius, the Netherlands, and the US remained top sources of FDI. The manufacturing sector also saw increased interest, particularly in electronics, automobiles, and pharmaceuticals.
Portfolio Flows and CAD Financing
Despite the FDI rebound, portfolio investment flows have been volatile and insufficient to cover the current account deficit. In April-May 2025, net portfolio inflows were only $2.1 billion, compared to the CAD estimated at around $12 billion for the period. This gap has been partly financed by other capital flows, including external commercial borrowings and banking capital.
The RBI noted that while foreign portfolio investors (FPIs) have shown interest in Indian equities and debt, global uncertainties, including US interest rate expectations and geopolitical tensions, have kept flows constrained. The central bank has been using its foreign exchange reserves to manage volatility, with reserves standing at $620 billion as of June 2025.
Implications for the Economy
The shortfall in portfolio flows for CAD financing could exert pressure on the rupee, which has already depreciated around 3% against the US dollar in the current fiscal year. Analysts expect the RBI to allow some depreciation to support exports, while using reserves to prevent sharp volatility. The current account deficit is projected to widen to 2.5% of GDP in FY26, up from 1.8% in FY25, driven by higher oil imports and domestic demand.
On the positive side, the FDI rebound suggests long-term confidence in India's growth story. The government's focus on infrastructure, digitalization, and green energy is attracting strategic investments. However, the reliance on volatile portfolio flows to bridge the CAD remains a vulnerability, especially if global financial conditions tighten further.
The RBI's monetary policy stance, with interest rates likely to remain elevated, may help attract some portfolio flows, but the pace of inflows will depend on global cues. Overall, the external sector outlook is stable but requires continued policy vigilance to ensure adequate financing of the current account deficit without undue pressure on the rupee and reserves.
