Modi's Third Term: India's Growth Story Faces Its Biggest Stress Test

Introduction: The Fading Halo

As Indian Prime Minister Narendra Modi enters his 12th year in power, his personal approval ratings remain strong, but the enthusiasm of international investors surrounding the "India growth story" is cooling. The Indian market, once seen as a safe haven for global capital, is now experiencing a crisis of confidence.

According to data from the National Securities Depository Limited of India, foreign portfolio investors have net sold $29.5 billion in Indian stocks so far in 2026, compared to just $18.9 billion for the full year of 2025. This is not a short-term fluctuation but reflects a reassessment by global capital of India's structural economic problems.

Capital Flight: From "One-Way Bet" to "Selective Retreat"

Alexandra Hermann-Prasad, chief economist at Oxford Economics, points out: "India is no longer the obvious one-way growth story that investors thought it was a few years ago." Although still strong by global standards, weak consumption, fragile investment confidence, rising energy costs, and selective global capital allocation are combining forces.

Foreign Direct Investment (FDI) data is even more concerning. The rolling 12-month total as of January 2026 exceeded $90 billion, up 13% year-on-year, but the repatriation of profits by foreign companies and a surge in overseas investments by Indian enterprises have driven net FDI to "near-historic lows." The declining quality of capital inflows, coupled with current account pressures, has led to a sustained depreciation of the Indian rupee against the US dollar. For an economy that imports 85% of its crude oil, this forms a dangerous cycle.

Reform Slowdown: Unresolved Structural Barriers

The pace of reforms in the Modi government's third term has noticeably slowed. According to the CSIS India Reform Scorecard, only 2 out of 30 major reforms have been completed in the past two years—far lower than in the first and second terms. Richard Rossow, senior adviser at CSIS, notes that land acquisition procedures and dispute resolution have not notably improved, labor regulations have seen only minor changes, and reliable, affordable electricity and water supply "remain core challenges to India's industrialization goals."

Last Friday, the Indian government announced the exemption of capital gains tax for foreign investors in the Indian bond market, seen as a timely move. However, Stephen Davis, CEO of Javelin Wealth Management, commented: "This helps improve the atmosphere, but it doesn't change the symphony. We need to see more market-friendly policies."

The Age of AI: A "Survival Crisis" for the IT Services Industry

Global equity research firm Bernstein warned in an open letter to Modi that AI advancements are threatening high-quality jobs in India's information technology sector. The IT services industry accounts for about 8% of India's GDP, directly employs 5 million people, and indirectly affects tens of millions of consumers. If India becomes a "permanent consumer of the AI economy"—unlike the United States and China, which have their own proprietary AI models—then the high-quality jobs lost will not be compensated by low-end employment in data centers.

CONTEXT_AFTER: Venugopal Gar, head of India research at Bernstein, said: "India has already missed the AI train."Bernstein India research head Venugopal Gar said: "India has missed the AI train." This is not only about export competitiveness, but also about the sustainability of the domestic consumption engine.

Geopolitical Storm: The Shadow of "Stagflation" Under the Middle East Crisis

The ongoing escalation of the Middle East conflict and the surge in international oil prices have exposed India's vulnerability as a major crude oil importer. On June 5, the Reserve Bank of India raised its inflation forecast to 5.1% while lowering its economic growth forecast from 6.9% to 6.6%. Inflation erodes real incomes, forcing the central bank to maintain high interest rates, further suppressing investment and consumption.

Sujit Bala, a former member of the Economic Advisory Council to the Prime Minister of India, called on the government to use the economic pressure brought by the Middle East crisis to push reforms, but no substantial measures have been seen yet.

Conclusion: The Next Chapter of the Growth Story

What India faces is not a cyclical slowdown, but the growing pains of structural transformation. The growth model driven by the demographic dividend, service exports, and cheap capital over the past decade is now encountering multiple shocks from AI technological disruption, global supply chain restructuring, and geopolitical risks.

To regain investor confidence, India needs to shift from "tax cuts" to "breaking barriers" — making substantial reforms in deep-rooted areas such as labor market flexibility, land acquisition, power supply, and digital infrastructure. Otherwise, the halo of "fastest growth in the world" may fade faster.