India’s External Strength Masks a Growing Vulnerability Problem

In gauging India’s external vulnerability, it might be useful to briefly review the terms “resilience” and “vulnerability.” The former refers to an economy’s ability to stay on its growth trajectory when hit by a shock, be it a spike in crude oil prices, a rumble in global financial markets or a sudden increase in tariffs by a major trading partner. Vulnerability is a slightly broader term that factors in the frequency of these shocks and their magnitude.

One must emphasise the fact that resilience does not mean a steady currency. In fact, the effort to keep the exchange rate stable over a long period often diminishes its competitiveness and makes it vulnerable to deep corrections when the tide of capital flows turns, a phenomenon that the rupee market is witnessing all too clearly.

The traditional approach to measuring resilience is to compare the quantity of foreign exchange reserves to the essential payments that need to be made. This is a stress test that asks the extreme question: how comfortably can an economy finance its external commitments if all inflows on the capital and current accounts dry up? There is no doubt that India is well placed on that front.

The IMF’s cross-country database updated in October 2025 showed that India could pay for 8.5 months of its imports from reserves. Reserves are roughly 2.3 times its short-term debt, the highest amongst its BRICS peers. The fund computes an Assessing Reserve Adequacy (ARA) metric that bakes in these commitments along with other, less visible, components. A reserve-to-ARA score of 100 is deemed comfortable. It was at 111 in October. The RBI did spend a bit of its forex balance—roughly about $13-15 billion—to defend the rupee since September, but this is unlikely to have pulled the ratios down significantly.

These ratios cannot be seen in isolation from so-called domestic fundamentals in measuring resilience. A relatively strong economy, particularly a robust banking and financial system and fiscal consolidation need to back these numbers up. India does well on this count. One can carp endlessly on the upward bias in official GDP estimates, but it is difficult to deny the fact that India is on a growth path of over 6%, impressive enough by any standard. The capital adequacy ratio of Indian banks is over 17%, compared to the internationally accepted comfort Basel threshold of 9%.

Besides, India has the somewhat unique advantage of not having issued a government bond in global markets, which spares it from the excessive fretfulness of foreign investors that can drive large swings in sovereign borrowing costs. Research also shows that a large amount of reserves themselves acts as a brake on outflows.

So far so good.

Shock Frequency
The problem lies not in the resilience to a one-time shock but in the frequency of these shocks. To analyse this, it is important to take a step into the realm of geopolitics. India’s policy of non-alignment (sitting on the fence to the cynics) with global powers has made it prone to both across-the-board global shocks and idiosyncratic shocks specific to itself. 

The détente in relations with the US has been the major problem, resulting in punitive tariffs and a general uncertainty across a wide range of issues, from H-1B visas to military supplies. Besides, the fact that it is surrounded by bellicose neighbours forever seeking to pick a fight enhances India’s political risk and its external vulnerability. Finally, in a world where foreign policy has become transactional, India lacks leverage in either rare-earth reserves or proprietary technology. 

The frequency of shocks affects resilience. Each shock leaves the external balances a bit bruised, its reserves a little more depleted, and its resilience a tad weaker.

A discussion on India’s vulnerability would be incomplete without dwelling on the new mantra that drives capital flows and investments--innovation, particularly in tech and alternative energy. India’s historically low R&D spend remains below 1%. While it scores high on the IMF’s AI preparedness index, implying that it would adopt AI well, there are doubts about its ability to contribute to the AI and tech ecosystem. It is, for instance, disappointing to see that for an economy, once considered a heavyweight in IT, ahead of China, it does not have anything close to its own “Large Language Model”.  

Besides, India is not plugged into any “new tech” supply chain. Contrast this with, say, Malaysia, which is rapidly positioning itself as an AI hub through its vast SEZs. In fact, ASEAN as a whole is working collaboratively to feed off China’s innovation engine. On the other hand, India’s current image is that of an economy driven by a vast market but low average spending that is moving forward on the back of public investments. 

If this continues and India falls back decisively in the innovation race, its ability to attract foreign capital is likely to diminish. This could impair both resilience and growth. One hopes that the upcoming budget will recognise this and at least start the process of a reset.