In the last column I had analysed why the impact of oil shocks may not be as large as markets seem to be pricing in. But there are other reasons why markets tend to overestimate risks for India.

Diversity as risk mitigation

There is a belief that India has missed the AI bus, with investors preferring to go to countries in the race. But quite a few Indian AI applications have been highlighted recently. In past tech-led booms the major gains have come from applications. Small language models (SLMs) distilled from large ones and trained on more relevant data are cheaper to run.

Productivity gains of 30 per cent are feasible and will raise incomes and demand. Software companies will play a large part in adapting and applying such SLMs and in other customisations.

Household participation in equity markets has risen and the current volatility is thought to be endangering both household participation and their savings. But the equity and mutual fund share of household financial savings is still only 15 per cent, and physical assets dominate household net worth giving them a good mix of assets.

Equity is not bought from leveraged funds, so there is no pressure to sell when markets are down. Having been through several cycles, households know better than to do so. Their mutual fund SIPs are sustaining. Households, and those who invest for them, believe in the India growth story and understand how to buy in dips. The large derivative trade is predominantly through regulated institutions who understand the risks.

In a $3.92-billion economy even a small percentage of GDP coming into stock markets is large in absolute amounts. In 2025 domestic equity ownership has overtaken that of FPI, which, at about 15 per cent, is at a 20-year low. Comparatively, in the US 18 per cent of domestic equity is held by foreigners. In China it is 3-5 per cent. India will do well to keep this number low. More domestic participation will reduce dependence on FPI and increase returns on household savings. It has already reduced volatility of stock market indices, which kept rising through the Ukraine conflict and have only shed some gains now after more than a year of external shocks and FPI exit.

Indian private investment, domestic savings and consumption demand are all criticised as inadequate. But investment ratios of above 30 per cent are the 5th highest in the world and only behind China’s 40 per cent among large economies. This is mostly private since public investment to GDP ratio is only 4 per cent.

The unorganised sector is enumerated as part of the household sector in India. This sector is borrowing and investing. Household net financial savings to GDP ratio fell, therefore, but the savings in physical assets ratio rose. Gross domestic savings remain above 30 per cent since corporate savings are rising. In the past, savings ratios have risen with growth. The current account deficit, a measure of foreign savings used, remains low at about 1 per cent.

The demand response to the GST tax cut last year has shown corporates that there is demand in India at appropriate prices and the government has tools as well as intention to moderate external shocks. Corporate investment has also picked up as manufacturing is set to benefit from free trade agreements (FTAs), green substitutions, demand for defence exports and construction. Agriculture and service exports add to Indian diversity. Even so, India’s consumption/GDP percentage of about 60 makes it less dependent on exports as a source of demand, compared to China where it is about 40.

Global shocks

It is strange that there is no onus on the international financial architecture to reduce the volatility emerging markets (EMs) face from global events. Maintaining stability of the international financial system is the mandate of international institutions. But they have shrugged off responsibility and do their best to convince EMs that volatility is due to something ‘structurally’ wrong with them.

Believers in free markets continue to advise EMs to reduce reserve accumulation and intervention: Currencies should float even if they tend to overshoot. Markets themselves like reserve accumulation, but not the reverse. Practical central bankers, however, know multiple instruments, including buffers, have to be used to manage external shocks and persistent misalignment. Diverse actions reduce risk!

Reserves fell only in six out of 30 years when outflows reduced the capital account surplus to below the CAD. The last 2 Trump-regime volatility years are included in the six. Why shouldn’t reserves accumulated in so many surplus years be used to moderate depreciation in the few years of outflows?

Strategically, intervention is avoided at the onset of outflows so they take a loss. In 2025, however, the rupee was allowed to over-depreciate in the hope that it would help solve balance of payments pressures. The rupee depreciated with the dollar although other currencies were appreciating, yet this did not improve either CAD or inflows. The 40 country real exchange rate (REER) depreciated 10 per cent over its long-run equilibrium level to which it has always returned after past outflow episodes. In theory real depreciation should encourage exports and discourage imports. But Indian exports largely go to competitive markets where currency gains have to be shared, while there is immediate full price increase in commodity imports.

A falling nominal exchange rate discourages foreign inflows, since they expect the fall to continue. They prefer coming in only when they are confident a reversal has set in. Benefits from rupee reversal outweigh those from higher interest rates or lower hedging costs.

After the Middle-East conflict long dollar positions increased in the belief the rupee would continue to depreciate, although it was already over-depreciated. Measures are required to arrest what can become a self-fulfilling cycle.

More nominal depreciation is unlikely to deliver real depreciation since it would only further raise the price of oil imports and inflation, which causes the real appreciation. It is better if the 100 REER value is reached through nominal appreciation than through inflation.

India does need to reduce its trade deficit but a competitive real exchange rate can only be one component of its strategy. Others include trade diversification in products, sources and destinations, more FTAs, a big push for green energy and reduction in logistics costs. The Middle-East conflict will give a boost to all of these. Already net oil imports/GDP has trended down from 8.5 per cent to 5.5 per cent. Oil exporters should worry.

India also needs to reduce its vulnerability to FPI volatility by reducing the CAD and increasing the more stable means of financing it. The stock of FDI to GDP in the US was about 20 per cent in 2024, in China it averaged 21.6 since 2005; in 2024 had fallen to 19.3. India’s 14 per cent value can be increased towards 20 per cent by allowing more Chinese FDI.

Analysts and rating agencies who focus only on broad averages and past vulnerabilities miss the many sources of change and resilience. Post-pandemic outcomes, therefore, have tended to outperform expectations.

The writer Professor Emeritus, IGIDR

Published on May 5, 2026