The government and Reserve Bank of India (RBI) have taken coordinated steps to spur foreign inflows and prop up the rupee.

Investors expect the moves to trigger a flow of $50 billion into Indian bonds and stocks this year. A prolonged outflow had plunged the rupee to a series of historic lows this year.

The currency and bonds rose on the news but the reality is that India’s economy is facing a gloomy outlook, reports Bloomberg. The Iran war is dragging on and straining energy supplies, fuel and fertiliser costs have soared, food prices are at risk of spiking and there’s still no trade deal with India’s biggest trading partner, the US.

These uncertainties are leading economists to downgrade their forecasts to well below the 7% pace that’s made India in recent years the world’s fastest-growing major economy. The RBI on Friday projected growth of 6.6% in the fiscal year through March 2027, down from 7.6% last year. 

Economists point to the widening gap between India’s foreign inflows and outflows as a structural factor that’s weighed on the currency and growth, reports Bloomberg. Part of the reason for that is India’s struggle to attract long-term capital through foreign direct investment (FDI). Net FDI has declined from $28 billion in 2022-23 year to just $7.7 billion in the year that ended in March.

So, what are the reasons why FDI is staying out? According to Dhiraj Nim, an economist at Australia & New Zealand Banking Group, a number of factors have combined to keep net FDI in India subdued. India is not a big player in the major tech sectors currently in vogue with foreign investors, such as chip manufacturing, electric vehicles or AI. At the same time, the growth of AI is posing a threat to India’s long-vaunted services sector, dampening investment. Broader forces like weak global trade and high interest rates are also a factor, he said.

“We don’t have those large sectors where globally trade is currently growing frantically in,” Bloomberg quoted Nim as saying. “I think that’s a reason why FDI has stayed out or at least not come in hordes like we’re used to seeing.”

On Friday, the government cut the capital gains tax on bonds bought by foreign buyers while the RBI announced a slew of measures to make it easier for foreign investors to buy government bonds and stocks.

According to Indranil Pan, chief economist at Yes Bank, these steps could lead to inflows of up to $45 billion, almost enough to close India’s balance of payments gap for the fiscal year. However, this could provide only temporary relief and longer-term problems would remain.

“Unless more structural issues like ease of doing business, reforms in manufacturing sector and job growth are not addressed, India won’t be totally out of the woods and will continue to be exposed to global headwinds,” the Bloomberg report quoted Pan as saying.

The US-Iran war has put pressure on India’s economy as it imports about 90% of its oil needs, 40% of which passes through the Strait of Hormuz. Higher oil prices have meant Indian buyers have had to offload ever more rupees in order to buy dollar-denominated crude, putting heightened pressure on the currency, the Bloomberg report states.

Until the war in Iran, India’s economy had been showing signs of recovery, boosted by easier monetary policy and new trade agreements struck with the European Union and others.

Before the war “it looked like the macro setup was pretty favourable,” Bloomberg quoted James Thom, a senior investment director at fund manager Aberdeen Investments, as saying. “I still believe that the underlying long-term structural growth story in India is intact.”