India’s external sector outlook in FY26 is being shaped by a complex interplay of robust services exports, resilient remittance inflows, and mounting headwinds across merchandise trade, particularly in the wake of US tariff actions.

According to a recent report by ICRA, India’s services trade surplus is expected to reach a record $205–207 billion in FY26, cushioning the economy against external pressures despite weak goods exports. This record surplus is emerging as a bright spot even as the current account deficit (CAD) faces renewed volatility.

In Q1 FY26, the CAD narrowed sharply to $2.4 billion (0.2 per cent of GDP), a marked improvement compared to the $8.6 billion deficit (0.9 per cent of GDP) in Q1 FY25. Importantly, the outturn was also well below ICRA’s earlier forecast of 0.7 per cent of GDP, underpinned by stronger-than-expected remittance inflows and buoyant services trade earnings.

Notably, India’s earnings from invisibles—comprising software exports, financial services, business outsourcing and remittances—rose by 19.9 per cent year-on-year to $66.1 billion in Q1, effectively offsetting the elevated merchandise trade deficit of $68.5 billion for the same period.

However, warning signs are evident for the upcoming quarters. ICRA projects that the CAD will widen substantially in Q2 FY26 to $13–15 billion (around 1.5 per cent of GDP), primarily due to a sharp expansion in the merchandise trade deficit. A principal factor behind this dynamic is the recently imposed 50 per cent tariff by the United States on a large basket of Indian goods, including critical export categories such as textiles, diamonds, seafood, and leather.

These sectors represent significant foreign exchange earners for India, and sustained tariff pressure could erode competitiveness. Should these tariffs persist through FY26, ICRA estimates that the CAD may rise above 1 per cent of GDP for the full fiscal year, versus 0.6 per cent recorded in FY25.

On the capital account front, India witnessed modest resilience. Q1 FY26 registered net financial inflows of $8.1 billion, reversing outflows that dominated the latter half of FY25. However, the pace of reserve accumulation moderated, with the Reserve Bank of India’s foreign exchange reserves increasing by $4.5 billion in Q1, sharply lower relative to the $8.8 billion accretion in Q4 FY25. As of August 22, forex reserves stood at a robust $691 billion, continuing to provide an important buffer against external vulnerabilities.

Currency markets have also reflected the strains of global trade headwinds and monetary divergences. The Indian rupee depreciated by 3.2 per cent against the US dollar in calendar 2025 (up to September 1), with ICRA projecting the exchange rate to trade in the range of ₹87.0–₹89.0 per USD in the near term. This trajectory reflects both the strength of the US currency and the pressure on India’s external balances from tariff-induced export compression.

Looking ahead, the external sector will be critically shaped by tariff-related developments with the United States, which remains India’s largest export destination. A prolonged tariff regime could structurally depress merchandise earnings, limiting India’s ability to offset trade imbalances through services and remittances alone. Conversely, any resolution or rollback of tariffs would provide immediate relief, enabling India to leverage its current momentum in services exports to sustain external stability.

India’s external balance situation in FY26 is fragile but not alarming, underpinned by record-high services trade surpluses and stable remittance inflows, but facing considerable downside risk from trade policy shocks. The policy priority will remain on safeguarding services competitiveness, maintaining capital inflows, and managing currency stability while navigating the fallout of tariff escalations in global markets.

Based On IANS Report