India's Rupee Globalization Strategy and Its Implications for Market Liquidity and Foreign Investment

India's push for rupee internationalization has gained momentum in 2025, driven by a combination of structural reforms, capital market liberalization, and strategic partnerships. However, the nation's readiness to manage increased foreign capital flows and sustain long-term investment hinges on resolving contradictions in its foreign direct investment (FDI) dynamics and accelerating market liquidity enhancements.

RBI Reforms and the Path to Rupee Globalization

The Reserve Bank of India (RBI) has taken decisive steps to reduce dependency on the U.S. dollar and promote the rupee in cross-border transactions. Amendments to the Foreign Exchange Management Act (FEMA) now allow non-residents to use repatriable INR accounts for foreign investments, including FDI in non-debt instruments, according to BIS data. Additionally, BIS also notes that Indian exporters can open foreign currency accounts overseas, streamlining trade settlements and reducing hedging costs. These measures align with bilateral agreements with central banks in the UAE, Indonesia, and the Maldives to facilitate trade in local currencies, as discussed in a Modifi post.

The RBI's reclassification of Foreign Portfolio Investment (FPI) to FDI under specific conditions further underscores its intent to attract stable capital. However, sectoral restrictions and government approvals for investments from neighboring countries highlight the need for regulatory clarity, as an IAS Point analysis explains. While these reforms signal progress, their effectiveness will depend on consistent enforcement and alignment with India's broader economic goals.

FDI Paradox: Gross Inflows vs. Net Outflows

India's FDI landscape in 2024–25 reveals a stark paradox. Gross FDI inflows rose by 13.7% to $81 billion, driven by interest in manufacturing, financial services, and energy, according to an InsightsOnIndia article. Yet, net FDI plummeted to a record low of $0.4 billion due to surging outward FDI (OFDI) and capital repatriation. OFDI surged to $29.2 billion in FY 2024–25, reflecting Indian firms' global ambitions in sectors like technology and pharmaceuticals, as noted in an ODR India analysis. This net capital reversal-where net FDI plus FPI minus OFDI fell to -1.25% of GDP-raises concerns about capital flight and structural vulnerabilities, a trend also highlighted by the ODR India analysis.

The sectoral composition of FDI exacerbates these concerns. Manufacturing's share in FDI has declined to 12%, while financial services and energy have become dominant recipients, as the InsightsOnIndia article observes. A significant portion of inflows originates from tax havens like Singapore and Mauritius, suggesting that much of the investment lacks long-term productive value. As noted by the RBI and discussed in the IAS Point analysis, this trend reflects a maturing market with fluid investor behavior but also underscores the need for policies to incentivize job-creating, capital-intensive investments.

Market Liquidity and Structural Bottlenecks

India's bond market has expanded to $2.69 trillion as of December 2024, with corporate bonds surpassing $602 billion, according to the InsightsOnIndia article. However, market depth remains shallow compared to developed economies, at just 0.65x equity market capitalization versus 1.2–2.0x in mature markets. This gap limits the ability to absorb large foreign capital inflows without destabilizing domestic interest rates.

Foreign exchange turnover data for Q2 2025, while not explicitly detailed, indicates global OTC FX trading averaged $9.6 trillion daily in April 2025, up 28% from 2022, a point the IAS Point analysis highlights. India's participation in this ecosystem is critical for rupee internationalization, yet liquidity constraints persist. The RBI's weekly FX turnover reports highlight short-term volatility but lack granularity on systemic resilience, a limitation noted in the InsightsOnIndia article.

Structural reforms in labor and land policies remain pivotal. The four consolidated labor codes-Wages, Industrial Relations, Social Security, and Occupational Safety-were harmonized across states by March 31, 2025, with phased implementation expected by 2027, as the ODR India analysis outlines. While these codes aim to streamline compliance and enhance worker protections, challenges in enforcement and sectoral adaptability linger. Similarly, land acquisition under the 2013 LARR Act has seen digital innovations like GIS mapping and blockchain registries, but delays in compensation and bureaucratic hurdles persist, a concern raised in the IAS Point analysis.

Implications for Foreign Investment and Economic Resilience

India's readiness to manage foreign capital flows hinges on three pillars: policy stability, sectoral rebalancing, and liquidity deepening. The IMF has emphasized the need for labor market reforms, reduced trade restrictions, and public investment to strengthen growth fundamentals, a recommendation echoed in the InsightsOnIndia article. Meanwhile, the RBI's focus on quality FDI-targeting manufacturing and green technology-must be paired with incentives to retain capital.

For foreign investors, the current environment presents both opportunities and risks. The inclusion of Indian government bonds in emerging market indexes has spurred $11.5 billion in net FPI inflows since June 2024, a development tracked in the ODR India analysis. However, the volatility of net FDI and OFDI suggests that capital may remain speculative unless structural reforms address long-term bottlenecks.

Conclusion

India's rupee globalization strategy is a work in progress, marked by bold reforms and persistent challenges. While the RBI's efforts to reduce dollar dependency and liberalize capital flows are commendable, the paradox of high gross FDI and low net inflows underscores the need for targeted interventions. Strengthening labor and land policies, deepening bond market liquidity, and ensuring consistent enforcement of FDI regulations will be critical to transforming India into a magnet for sustainable, high-quality foreign investment.