Continuous sell-off by foreign investors may pressure India's balance of payments

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A report by DSP Asset Managers has highlighted that if the ongoing sell-off by foreign investors is combined with a sharp rise in crude oil prices, India's Balance of Payments (BoP) could face significant pressure.

According to the report, foreign inflows, particularly from Foreign Institutional Investors (FIIs) in the equity markets, are not only key drivers of stock prices but also play a vital role in maintaining macroeconomic stability in India. The report stressed that in the event of a sharp increase in oil prices, coupled with large-scale FII sell-offs, India's BoP could deteriorate rapidly, which would put a strain on the country's economic balance.

India's dependency on imported crude oil has been a historical challenge. As noted in the report, crude oil is a crucial input for the nation's economy, and every time oil prices surpass USD 100 per barrel, India's merchandise trade deficit expands significantly, putting added pressure on the nation's economic resilience.

However, over the last decade, rising net flows from services exports and remittances have acted as a cushion, offsetting the negative impact of high oil prices on India's BoP. The report pointed out that despite crude oil reaching USD 100 per barrel, these inflows have been successful in keeping India's merchandise trade deficit under control.

"In years when India faces an oil shock, foreign inflows come to its aid," the report stated. Despite this buffer, India is not immune to external shocks. When oil prices rise unexpectedly, the BoP position becomes fragile, and India has often relied on foreign capital inflows to stabilise its finances.

For instance, during the 2013 crisis, the Reserve Bank of India (RBI) launched the USD 34 billion Foreign Currency Non-Resident (FCNR) deposit scheme to attract dollar inflows, providing the country with much-needed support. Similarly, in the financial years 2013, 2018, and 2019, India raised substantial foreign loans to manage deficits.

The report warns that if capital inflows were to fall short, it could lead to a currency crisis, forcing the RBI to step in. "When India's financial and capital accounts are unable to cover the current account deficit, a currency threat looms, which the RBI must manage," it said.

As per the report, ensuring a steady flow of foreign investments is crucial for India's economic stability, especially during times of volatile oil prices and uncertain global capital movements.

(With inputs from ANI)