Emerging challenges: India needs to do more to attract stable capital flows

Falling oil prices offer India short-term relief, but the RBI warns that geopolitical tensions and shifting global capital flows continue to pose financial stability risks

The agreement between the United States (US) and Iran, and the reopening of the Strait of Hormuz, has had a calming effect on prices of crude oil. Prices have declined to pre-conflict levels, providing much-needed relief to a country like India, which depends on imports for most of its requirements of crude oil. Oil-marketing companies on Wednesday reduced the prices of liquefied petroleum gas in select categories. They also brought down the prices of aviation turbine fuel. More such corrections can be expected in the coming weeks if oil prices remain at lower levels. Although things may be returning to normal, the conflict exposed the vulnerabilities India faces in an increasingly geopolitically fragmented world. The latest biannual Financial Stability Report (FSR) of the Reserve Bank of India (RBI) does well to recognise the increased risks of adverse external shocks. 

RBI Governor Sanjay Malhotra rightly noted in the foreword that, in the current environment, preserving financial stability and building systemic resilience had become more important than ever. The crisis threatened to substantially increase the current-account deficit (CAD) at a time when India is facing difficulties in attracting foreign capital for a variety of reasons. As the FSR noted, while the CAD remained at manageable levels in 2025-26, the overall balance of payments (BoP) remained in deficit for the second year in a row. With higher oil prices, there was a strong possibility that the current year would have ended similarly, though how the external account evolves remains to be seen in the coming quarters. Recent measures by both the RBI and the government are expected to improve capital flows, though mostly in the form of debt. The issue worth debating in this context is why the BoP has been in deficit over the past two years. Have global financial conditions changed fundamentally? 

In managing the external account, a few things need to be carefully watched. Given the inflation conditions, it is likely that interest rates in advanced economies will remain at a relatively high level. Financial markets, for instance, are bracing themselves for at least one rate increase this year by the US Federal Reserve. This will tighten global financial conditions. Further, higher global debt is affecting bond markets and capital flows. As the FSR has also highlighted, some of the large countries, including the US, have shortened the average maturity of debt issuances because of rising term premiums. Sustained large refinancing requirements would influence yields and capital flows. Besides, global risk capital is moving to the US. The data shows that gross foreign holdings of US stocks increased to $21 trillion in March 2026 , as against about $7.5 trillion in 2020. The alarm bells are growing louder on the risks posed by artificial intelligence-related investment and the level of concentration in such investment. 

Worryingly, investment is being increasingly financed through debt, which has different dynamics compared to equity. A shakeup in the artificial-intelligence (AI) world and a sharp correction in stock prices could lead to broader risk aversion in financial markets, affecting capital flows. In fact, India needs to be prepared for both outcomes — continued absorption of risk capital by AI-related businesses over the medium term, and a potential sharp correction in the stock prices of AI-related companies. Both scenarios will affect capital flows, though to varying levels. Thus, given the challenging environment in funding across the globe, owing to a variety of factors, India needs to substantially increase its attractiveness as an investment destination. Recent measures may not be sufficient to address the fundamental shifts in the global financing landscape.