With only enough cash in the Reserve Bank (RBI) to pay for seven months of imports, USD 172 billion of debt falling due in the next eight months and weak fund inflows, the balance of payments position is undermining its ability to defend a tumbling rupee.
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A heavy dependence on imported energy, gold and technology means India has historically run a current account deficit, which it has funded by attracting foreign money into stocks, bonds and corporate investment.
But as global investors turn away from emerging markets in anticipation of the US Federal Reserve starting to wind back its stimulus, India's weak external position makes it more vulnerable to outflows and a balance of payments deficit.
India has USD 280 billion of foreign exchange reserves. That is only enough to cover seven months of import bills, by far the lowest of the BRICs, the four major emerging market economies.
That has left the RBI with limited firepower to support a rupee which has fallen 12 percent since the start of May and hit a record low of 61.80 to the dollar last week.
India "can't afford to defend the currency much with such little reserves," a policymaker said, declining to be identified as he was not authorised to speak with media.
The RBI is said to consider three months of import cover to be the minimum acceptable level, but some central bank insiders are said to be uncomfortable that reserves have run down to the lowest in terms of import cover since 1996.
"The lower import cover continues to be a source of discomfort," said another policymaker.
"We would like to increase the import cover. If there is a gap in the BOP, then the currency will have to take a hit."
That said, India is not yet looking at a repeat of its 1991 crisis. Then, with only enough reserves to cover three weeks of imports, the government was forced to pledge its gold in order to pay its bills and had to push through reforms to start opening up the economy.
In the fiscal year that started in April, stocks have attracted a net USD 2.3 billion in inflows, but if that changes India could find itself with a balance of payments deficit. Debt has seen a net outflow of about USD 5.7 billion.
Stocks account for a whopping USD 220 billion of foreign holdings in India, according to Bank of America-Merrill Lynch. Debt makes up a comparatively small USD 81 billion in foreign assets, government data shows.
India ran balance of payments (BOP) deficits in 2008/09 and 2011/12. It posted a small surplus of USD 3.8 billion in the 2012/13 year that ended in March, but some economists expect it to slip back into deficit this fiscal year.
All up by the end of this fiscal year, India needs to refinance or repay USD 172 billion of liabilities - such as foreign borrowings, trade credit, and private debts - which is almost 45 percent of its overall external borrowings and equivalent to 59 percent of its reserves.
"We are vulnerable now," said Abheek Barua, chief economist at HDFC Bank in New Delhi.
"If this vulnerability manifests into one large default on domestic loans or external commercial borrowings, it could threaten a sovereign rating downgrade and that could trigger a balance of payments crisis," Barua said
Any corporate default is seen as more likely to be on domestic debt, but the risk is it would spoil the broader investment environment and hit already-slowing economic growth.
Investors are hoping the appointment of Raghuram Rajan, a former chief economist of the IMF, as RBI governor from September helps accelerate measures to stabilise the rupee.
Rajan has spoken of a sovereign or quasi-sovereign bond issue to attract dollar inflows, widely seen as an effective if costly stop-gap measure to support the rupee. Outgoing Governor Duvvuri Subbarao has spoken against issuing sovereign bonds.
While the government has put curbs gold imports and taken other measures to narrow the gap on external accounts, investors and economists believe much more is needed to attract long-term funds to help balance the external accounts.
The current account is in persistent deficit - there was a shortfall of USD 88 billion, or a record 4.8 percent of GDP in 2012/13 - but there are limits to what can be done to lower it.
The bill for oil, the largest and most inelastic of India's imports, was USD 169.4 billion in 2012/13, and a weaker rupee will only push up the cost further.
HDFC Bank's Barua expects India to end up with a balance of payment deficit of USD 12 billion to USD 15 billion in 2013/14.
"We are not close to the crisis situation seen in 1991, but it cannot be ruled out of a realm of possibility," he said.