An industrial and capex super-cycle is unfolding across Asia. Economies around the world are racing to spend more on AI and AI-related infra, energy security and transition, defence, and onshoring of industrial supply chains.
These drivers can help catalyse a capex cycle in India, too. This is particularly the need of the hour given the rising underemployment problem. If we want to create enough jobs for new entrants to the workforce and address underemployment, India's economy needs to grow at 12-14% in nominal terms for a decade.
But India faces a critical challenge - it needs to obtain funding to capitalise on this opportunity. Typically, this is usually sourced from two channels: rise in domestic savings supported by exports income, and rise in external financing or capital inflows. On both fronts, there are existing and future challenges to contend with.
As regards domestic saving, there is a need to bring about a virtuous cycle of higher export incomes, jobs and saving, similar to what was experienced in the 2000s. But the approach of deploying a large, skilled workforce into its services exports sector is coming under pressure from the rise of AI. This makes the task of boosting manufacturing even more urgent than before.
India needs to boost its competitiveness in manufacturing and lift its market share in global exports. At the same time, it should unleash competitive forces, lower barriers to entry and create conditions conducive to the flourishing of SMEs. Global manufacturers are looking for alternatives to diversify supply chains - especially in electronics manufacturing - and increasingly looking for domestic component sourcing.
More broadly, India will have to find ways to replicate the approach that China has successfully employed over the years:
- Foreseeing shifting trends in global demand and building capacity ahead of time.
- Executing with an integrated supply chain and ecosystem.
- Having a financial system aligned to strategic goals.
- Focusing on R&D and innovation.
- Ensuring its workforce is adequately skilled.
India must carefully nurture these areas over the medium term to ensure success in manufacturing exports. The most critical link is to implement and execute on an integrated supply chain and ecosystem across states. A systematic improvement in the ease of doing business across all levels of government is needed.
GoI will have to take the lead in coordinating these efforts to ensure active participation across states. For instance, a 500-member task force to plan, and a 10,000-member task force to coordinate execution with the state governments can be envisaged.
To be sure, these efforts to build up domestic savings will take time to bear fruit. So, there will still be a need to draw on external sources of financing through FDI or FPI. In the past, India has enjoyed strong capital inflows, which have more than offset CAD. However, the BoP situation has come under pressure more recently.
For foreign investors, India's relative growth story has become less compelling at the margin. Though there are early signs of improvement in corporate earnings, it compares less favourably than before. Markets more directly levered to AI and industrial supply chains - notably north Asian economies - have a far more powerful earnings impulse.
India's Q1 2026 earnings are expected to grow 12% y-o-y. That looks less compelling next to South Korea at 152%, Taiwan at 49%, Japan at 33%, and the US at 25%. While the rupee has weakened significantly, the equity market has not, cushioned by the domestic bid for equities, which has remained strong.
But this actually further complicates the external funding picture. FPIs have been able to exit their investments at relatively high valuations with domestic investors stepping in. FDI inflows have also been weighed down by outward FDI, given repatriation amid PE and VC exits. This trend is also influenced by factors similar to those for FPIs.
Pressures on current account to ease as oil prices moderate are expected. But that on its own won't be sufficient to close the funding gap. The capital flows challenge predates the energy shock. So, the immediate question is what policy tools India can use to augment capital inflows.
There are two options worth considering:
Encourage companies, banks and PSEs to raise external commercial borrowings, with RBI providing some form of forex hedge support.
Improve the regulatory and tax environment for foreign investors by removing the withholding tax on debt investments and capital gains tax.
Of these, the more immediately effective may be the first: incentivising dollar borrowing by banks and state-owned enterprises through partial forex hedging cost protection.
Such augmentation of capital flows may be needed as an interim measure. In any case, policy reforms must accelerate from here to lift competitiveness, deepen manufacturing capacity, strengthen global value chain participation, and raise domestic savings so that investment can accelerate without putting persistent pressure on BoP. Doing so would boost India's attractiveness as an investment destination - and ensure there's sufficient job creation for its growing labour force.
