External sector: trade, BoP, FDI

The Balance of Payments: structure

The balance of payments (BoP) is the systematic record of all economic transactions between residents of India and the rest of the world over a year, compiled by the Reserve Bank of India under the Foreign Exchange Management Act (FEMA), 1999 and reported in line with the IMF's Balance of Payments Manual (6th edition, BPM6). The BoP has two principal accounts.

The current account records trade in goods (the merchandise/trade balance), trade in services (software, travel, transport — India's services surplus is structurally large), primary income (investment income, compensation) and secondary income (remittances). India received roughly US$125 billion in remittances in 2023, the largest of any country per World Bank data, which substantially finances the merchandise trade deficit. The current account deficit (CAD) is the headline metric: it was 1.2% of GDP in FY24, comfortably below the danger zone, against a crisis-era peak of 4.8% of GDP in FY13 that triggered the 'taper tantrum' rupee slide.

The capital account (the capital and financial account in BPM6 terms) records foreign investment (FDI and portfolio/FPI flows), external commercial borrowings (ECBs), banking capital and the change in foreign exchange reserves. A current account deficit must be financed by a capital account surplus or a drawdown of reserves; the two accounts plus errors and omissions sum to zero by construction. India's forex reserves crossed US$700 billion in 2024, providing import cover of roughly 11 months.

Trade balance and composition

India runs a persistent merchandise trade deficit — imports exceed exports, dominated by crude petroleum, gold and electronics. China is India's largest source of imports, generating a large bilateral deficit. On the export side, petroleum products, gems and jewellery, pharmaceuticals, engineering goods and — within services — software exports are the mainstays. India's total exports (goods plus services) approached US$770–780 billion in FY24.

Trade policy is set through the Foreign Trade Policy (FTP) 2023, administered by the Directorate General of Foreign Trade (DGFT) under the Foreign Trade (Development and Regulation) Act, 1992. Schemes include the Remission of Duties and Taxes on Exported Products (RoDTEP) and the Production-Linked Incentive (PLI) schemes launched from 2020 to boost manufacturing exports. India is a founding member of the WTO (1995) and uses anti-dumping duties via the Directorate General of Trade Remedies. It withdrew from the RCEP negotiations in November 2019 over concerns about Chinese import surges and inadequate safeguards — a high-frequency PYQ trigger.

FDI versus FPI: the two faces of foreign capital

Foreign investment enters India through two distinct channels. Foreign Direct Investment (FDI) is a lasting interest — the FEMA threshold treats 10% or more equity as direct investment — implying management control and long-term commitment; it is considered stable, non-debt-creating capital. FDI enters via the automatic route (no prior government approval, most sectors) or the government/approval route (sensitive sectors). Sectoral caps are set by the Consolidated FDI Policy and DPIIT press notes: 100% in most manufacturing, 74% in defence under automatic route (raised in 2020), 74% in private banking, 49% in insurance (raised to 74% in 2021), and FDI is prohibited in lottery, gambling, chit funds, and atomic energy. Press Note 3 of 2020 mandates government approval for investment from countries sharing a land border with India (notably China), tightening scrutiny after the pandemic.

Foreign Portfolio Investment (FPI) is investment in securities below the 10% threshold, regulated by SEBI. It is volatile 'hot money' — it flowed out sharply during the 2013 taper tantrum and again in 2022 — and is the swing factor in the capital account.

Exchange rate and external debt

India operates a managed float: the rupee is market-determined but the RBI intervenes to curb volatility, not to target a level. The rupee has depreciated structurally — around ₹45/USD in 2010 to beyond ₹83/USD by 2024. External debt stood near US$680 billion (about 19% of GDP) in 2024, with the short-term component a closely watched vulnerability indicator alongside the debt service ratio.

Why this matters for the exam

This topic is examined across Prelims (GS) and Mains GS-3 ('mobilization of resources; effects of liberalization on the economy; growth, development'). Prelims PYQs repeatedly test conceptual distinctions: which items fall under current versus capital account (a 2014 and 2018 staple), what FDI is versus FPI, and the meaning of the trade balance, invisibles and CAD. Examiners reward candidates who distinguish stable FDI from volatile FPI, who can state the 10% control threshold, and who connect a widening CAD to rupee depreciation and reserve drawdown. For Mains, frame answers around the 'twin deficit' problem (fiscal plus current account), the role of remittances and services exports in financing the deficit, and policy instruments — FTP 2023, PLI, RoDTEP, Press Note 3. Retain hard numbers: CAD as % of GDP, reserve levels, remittance rank, FDI caps. A factually anchored answer outscores a vague one.