Cross-Border Frictions in India and Impact on Growth - A practitioner's View

by G. Padmanabhan.

Abstract

Since 1991, India has sought to integrate more closely with the world economy. The scale of this engagement is now substantial. In 2025–26, exports of goods and services were over USD 863 billion, including USD 421 billion of services exports. Remittances are estimated at USD 135 billion. Yet these flows have not translated into commensurate investment. India is not among the ten largest recipients of FDI, and net fixed FDI has declined in nominal terms since 2020. This is striking at a time when global firms are reorganising supply chains and looking for alternatives to China. This paper argues that the lag in India’s growth, and the gap in its deep engagement with the world, is a problem of friction in the flow of data, capital and trade. Some of the problem lies in implementation: rules that are reasonable on paper are not administered efficiently. Some lies in the rules themselves: the regulatory design creates costs and uncertainty more so when implemented retrospectively. These costs matter because a firm does not experience each regulatory obstacle in isolation. A delay in an approval, an uncertain tax treatment, a restriction on data flows or difficulty in moving capital across the border all enter into the future decision to invest. The relevant cost is therefore not just the cost of complying with a particular rule. It is the investment that does not take place because the cumulative uncertainty makes India less attractive. This paper suggests a different approach to achieving efficiency. Cross-border friction should not be treated as a collection of unrelated problems to be fixed one rule at a time by incremental tweaking of rules or policies in isolation. The problems are connected because they affect the same decision: whether a firm will choose to engage with India. The first requirement is therefore to recognise cross-border friction as an overall architecture and a policy problem in its own right. The second is to examine the rules and institutions that create it and chalk out how they are to be addressed on an enduring basis.

India faces a throughput problem

Over the decades since liberalisation, India has put in place most of the components needed for deeper engagement with the world economy: exports, services trade, remittances and digital infrastructure. The components are no longer the main constraint. The problem is the efficiency with which they translate into investment and growth.

A simple comparison with other Asian economies makes the point. Table 1 scores the intensity of friction across five types of cross-border flow for four economies at different points on the openness spectrum.

Table 1: Relative intensity of cross-border friction, by flow type.

Flow type	India	China	South Korea	Taiwan
Trade	Moderate	Low–moderate	Low	Low
Capital	High	High	Low	Low
Technology	Moderate–high	High	Low	Low
Data	High	Very high	Low	Low
Financial	High	High	Low	Low

Source: Practitioner’s Research

India and China are both high-friction economies. China has been able to carry this friction given the scale it offers: the volume of its trade and capital flows, and the depth of its integration into global supply chains, allow it to absorb costs that are more consequential and costly for India. South Korea and Taiwan sit at the other end, with relatively low friction across each category. The point is not that borders should be frictionless. Every country regulates cross-border flows. The question is the price paid for the manner in which those regulations are designed and administered. India pays a high price.

Address frictions as an architecture

The usual instinct is to treat each of these frictions as a small, self-contained technical problem, owned by the agency that created it. This misses how firms experience regulation. The frictions interact because they affect the beliefs firms form about the policy environment. A firm that receives a trade-reporting notice for a transaction settled years ago, or encounters a new card-data requirement with little warning, does not necessarily treat the episode as an isolated nuisance. It updates its assessment of how India is governed. When it next considers bringing capital into India, that assessment enters the return it requires comparing with other markets. The cost of an individual friction is therefore not limited to the delay or dispute it creates. It is the increase in the risk premium attached to India, and the investment that may be lost as a result. This is why these domains cannot be addressed independently and every regulatory intervention needs to be weighed against higher stakes – the cost to Indian growth.

There are several reasons why India continues to produce such frictions. Some reflect limitations in state capacity. Some reflect isomorphic mimicry: the adoption of the form of an effective institution without its underlying function. And some reflect weaknesses in regulatory design. A state under pressure to appear modern can reproduce the institutional machinery of a successful system without reproducing the conditions that make it work. India provides several examples. Inflation targeting, for instance, exists formally through a statutory mandate and a monetary policy committee, while the exchange rate continues to be actively managed through intervention in the currency market.

The rest of this paper draws on the author’s experience of this machinery, at the Reserve Bank of India and in subsequent roles, to examine how Indian policy and regulation create cross-border friction. The cases that follow are grouped according to their underlying cause. The first are implementation failures: cases where the policy design was sound but its administration reintroduced the friction the reform was intended to remove. The second are design failures: cases where the problem lies in the rule itself, irrespective of how well it is administered. The closing section then turns to what a better approach would require. The cases draw on the author’s direct knowledge of events rather than on publicly available documentation; these are identified as such.

Observed Case Studies: Cross-Border Frictions

Implementation failures

Trade documentation: The Reserve Bank of India (RBI) introduced the Export Data Processing and Monitoring System (EDPMS) and its import counterpart, the Import Data Processing and Monitoring System (IDPMS), in 2014 to bring trade data held separately by the RBI, Customs and the Directorate General of Foreign Trade (DGFT) into a common system, tracking transactions from initiation to final realisation of proceeds. The objective was sound, but the implementation was not. Historical transactions that had never been reconciled were carried into a system designed to track future flows. Reporting gaps at the source compounded the problem. Firms now receive notices for transactions settled years ago and must spend time establishing what should already be clear: the matter is closed. Such notices are not merely an administrative nuisance. They disrupt a firm’s international business and undermine confidence in India’s systems for managing cross-border transactions. That experience shapes how firms assess the risks of doing business in India—and where they choose to invest next.

Data localisation: Data is now a cross-border flow in its own right, much like goods or capital. India’s approach to regulating data shapes firms’ ability to participate in global markets. In 2018, the Reserve Bank of India (RBI) mandated that payment data be stored in India through a brief circular that offered little guidance on implementation. Some card networks subsequently withdrew services dependent on cross-border data flows, including emergency card replacement for Indian travellers abroad. Uncertainty over localisation and tokenisation has also led foreign counterparties to abandon Indian use-cases rather than assume an unclear compliance burden. The Digital Personal Data Protection (DPDP) Act has not resolved all these uncertainties; the rules governing consent and cross-border transfers, for instance, still need clarification. For a firm operating across several markets, an activity permitted elsewhere may not be worth offering in India if compliance requirements remain unclear. The resulting cost is not confined to activities that regulation prohibits, as uncertainty alone can deter cross-border business.

Investment screening: The implementation of Press Note 3, introduced in 2020, created similar uncertainty for investors. In the days following its announcement, basic questions remained unanswered: what ownership threshold triggered the restriction, which entities were covered, and whether it applied to investments routed through India’s international financial centre. Subsequent clarifications did not settle every issue, and in some cases enforcement followed after investments had already been made. For an investor, the terms on which capital can be committed are part of the investment decision. A known restriction can be factored into the deal’s structure and expected return. An uncertain one introduces the risk of additional approvals, unforeseen costs or a change in regulatory treatment after the event. Investors may respond by spending more on legal advice and structuring, demanding higher returns, delaying transactions or abandoning them altogether. Retrospective changes, including reversals of earlier rulings, compound the problem. The rules have since been amended and clarified, but the delay itself has imposed costs. Uncertainty is not costless simply because the rules are eventually settled.

Design failures

Foreign Exchange Management: In many cases, India’s cross-border frictions also stem from conception and design. The Foreign Exchange Management Act (FEMA), 1999 replaced the Foreign Exchange Regulation Act (FERA), 1973, marking a shift from conserving foreign exchange through restrictive controls towards facilitating external trade and payments. The change was fundamental: under FERA, transactions were generally prohibited unless specifically permitted. FEMA reversed this presumption for current-account transactions, while retaining a permission-based framework for capital-account transactions.

This shift was partly reversed in 2017 by the insertion of money-laundering-style provisions under Section 13 of FEMA. Cases closed years earlier were reopened, including some relating to periods before the money-laundering provisions underpinning the new enforcement approach came into force. This did not just cause uncertainty for existing investors but also increased future regulatory risk, especially for investors committing long-term capital.

Duplicated KYC: The Central KYC Registry was created to reduce duplication such that a customer verified once could be considered approved across institutions, instead of being re-verified at each juncture. In practice, however, the registry has been bottlenecked by major system updates, rigid data-matching requirements and fragmented implementation across banks. When records cannot be retrieved, accepted or matched, institutions must conduct KYC again. For firms, particularly those operating across borders, this means additional compliance costs and uncertainty about whether existing documentation will be accepted. The problem extends beyond duplication: when firms cannot predict what compliance will require at each stage of a transaction, they face regulatory risk that can make investing in India less attractive.

Aircraft financing: Aircraft financing shows how a narrow regulatory interpretation can affect an entire industry. Indian airlines rely on sale-and-leaseback arrangements, a standard global practice that allows them to finance fleet expansion without buying aircraft outright. Treating these arrangements as merchanting transactions brought them within restrictions on the movement of funds, disrupting their use in India for some time. A question of foreign-exchange classification thus became a constraint on how airlines finance fleet renewal. It also carried an environmental cost, since newer aircraft are generally more fuel-efficient. A classification that appears technical to one regulator can change the terms on which capital is available to an industry, shape international financiers’ perceptions of the Indian market, and add to the frictions that constrain cross-border flows.

From silos to a system: what smarter regulation requires

Frictions like these interact across the system, so reform cannot proceed one rule at a time. Removing one constraint may simply leave a firm facing another further down the transaction. The aim should be to reduce the total friction a firm encounters when moving capital, goods, data or payments across borders. Three principles follow.

Treat cross-border friction as one subject

Any improvement in ease of doing business of investors requires an initial intellectual shift on the part of Indian policymakers. Cross-border friction should be treated as a single policy problem spanning trade, capital, data and payments, rather than as a collection of issues belonging to different agencies. This does not require a new super-regulator. It requires a common framework for assessing these frictions and clear responsibility for the points where they interact. India’s domestic digital infrastructure offers a useful precedent: identity, payments and data-sharing were developed as parts of a common architecture rather than as separate systems. Cross-border infrastructure needs the same approach. If the problem is treated as a collection of separate regulatory issues, reform will remain fragmented as well.

Assess regulatory interventions carefully

Viewing cross-border frictions as a single architecture means that each regulatory intervention has to be weighed against the frictions it creates elsewhere and the cost those frictions impose on growth. This raises the stakes of technical regulatory changes and policy innovations that seek to serve several objectives at once. A measure designed to address one problem can alter the cost or certainty of transactions elsewhere in the system. The assessment therefore cannot stop at whether the measure achieves its immediate regulatory objective; it must also consider what it does to the overall cost of engaging with India.

How can this be fixed? Rules are often drafted without sufficient understanding of how firms operate or consultation with those they regulate. Reform must therefore address not just the rules themselves, but how they are made and revised. Draft rules should be published for meaningful consultation, with rule-makers required to identify likely unintended consequences and offer explanations for unaddressed stakeholder concerns. Once implemented, rules should be reviewed after a defined period and modified in light of experience. Where the underlying design is flawed, they should be withdrawn rather than patched incrementally. The final decision should document which concerns were addressed, which were not, and why. This would make rule-making more responsive, transparent and credible.

Further, rules should arrive with the guidance needed to comply with them. Questions of interpretation should be settled in advance rather than through after-the-fact action, and the state should treat predictability as a key outcome in the process. Much of the friction documented here would dissolve through clear and predictable rulemaking.

Separate interpretation from macroprudential judgement

A related problem arises when regulators both make the rules and interpret and enforce them. Many frictions stem from routine interpretive questions: whether a sale-and-leaseback constitutes a merchanting transaction, an investment screen applies to a particular holding, or a deposit qualifies under a remittance scheme. Such decisions can have significant consequences for firms, yet are difficult to challenge when the same institution makes, interprets and enforces the rules.

Routine interpretation is not macroprudential judgement. Regulators need discretion to respond to systemic risks. But routine questions about how existing rules apply to specific transactions do not warrant the same deference. Treating the two alike shields ordinary regulatory interpretations from scrutiny that their consequences demand.

The two functions should therefore be separated. Regulators should retain discretion over macroprudential decisions, while routine interpretations of existing rules, including under FEMA, should be subject to independent appellate review. Firms must be able to challenge an interpretation before a body other than the regulator that issued and enforced the rule. This would make regulatory uncertainty contestable rather than a cost firms must simply absorb, while checking the gradual expansion of restrictions through interpretation.

Conclusion

India has spent three decades building the capacity to engage with the world. The friction that now blunts that capacity is not a scatter of technical irritants to be filed away with the agencies that produced them. It is a connected system of drag, in which each obstacle raises the price at which capital is willing to come, and it has to be understood and reformed as one thing.

The stakes are significant. Growth since the early 2010s has run below the country’s ambitions, and net foreign direct investment has weakened at a moment when supply chains are being reconfigured. Economies that have already stripped out friction will benefit more from that reconfiguration than those unwilling to change. Removing cross-border friction is one of the more direct levers India has for turning its hard-won global engagement into growth. India has shown that it can build complex domestic digital infrastructure by designing different systems to work together. The next task is to apply the same approach to its engagement with the world: to treat the movement of capital, goods, data and payments as a connected system, and reduce the frictions that prevent that system from working well.

G. Padmanabhan is the Former Executive Director, Reserve Bank of India. Several of the cases in Section 2 rest on the author’s direct experience of the events described rather than on published documentation, and are presented as practitioner testimony.