India has officially scraped capital gains tax on foreign portfolio investments in government securities, marking a significant milestone in attracting foreign investment. As reported by The Hindu BusinessLine, the Economic Times newspaper was the first to report Wednesday's cabinet approval of the plan, with the finance ministry confirming the development. The Union Cabinet has approved an ordinance to amend the Income Tax Act and exempt FPIs from capital gains tax on government bond investments, with the proposal now awaiting presidential assent before a formal notification is issued. This represents the government's commitment to implementing the tax relief measures announced earlier this week, moving from policy consideration to actual implementation. The move aims to attract sticky foreign inflows into debt, which could cushion the rupee's slide and boost demand for Indian bonds, according to private-bank traders. According to Bloomberg, the Union Cabinet is expected to discuss a proposal to reduce taxes paid by foreign portfolio investors (FPIs) on investments in Indian bonds, with the government also likely to consider either scrapping the existing 20 per cent withholding tax on interest income earned from bonds by overseas investors or reducing it substantially. The latest reports indicate that India is reportedly considering a major policy shift to attract more overseas capital, as the government looks to scrap or sharply lower the 20% tax on interest earned by foreign bond investors.
Citi's Head of Markets India Aditya Bagree projects that India could attract $20-25 billion in passive, stable inflows through two key policy initiatives. Speaking at a Citi investor conference that drew over 1,600 global clients to Mumbai, Bagree highlighted that removing the withholding tax on government bonds and securing inclusion in the Bloomberg Global AGG Index would together unlock substantial foreign investment. As reported by The Economic Times, these developments would strengthen India's balance of payments and ease fiscal pressures, with benefits rippling across multiple pressure points including a stronger balance of payments, supportive bid for government bonds, and incremental liquidity added to the banking system. The 10-year yield is expected to move toward 7.20-7.30% reflecting global concerns about oil-driven inflation and fiscal slippage, but index inclusion would provide meaningful counterweight to these pressures.
Foreign investors currently paid 12.5 per cent long-term capital gains tax on listed shares and bonds held for more than 12 months, with an additional 20 per cent withholding tax on interest earned in government bonds. The new tax relief eliminates these barriers, with the government having previously considered either scrapping the existing 20 per cent withholding tax or reducing it substantially. Market response has been positive, with India's benchmark 6.48% 2035 yield falling 2 basis points to 7.0033% by 10:45 a.m. on Thursday, as bond yields move inversely to prices. The one-year swap rate remained flat at 6.1050%, while the two-year rate was at 6.34% and the five-year rate was little changed at 6.6325%. The Union Cabinet is expected to discuss proposals that could significantly reduce the tax burden on foreign investors buying Indian bonds, with any reduction in the tax rate expected to improve the attractiveness of Indian debt instruments relative to other investment destinations. As per Reuters, the move is aimed at attracting foreign capital and supporting the rupee amid economic uncertainty stemming from the conflict involving Iran and elevated global energy prices.
Foreign investors have maintained net positive flows into Indian government debt this year, investing a net amount of $1.4 billion in bonds, while nearly $28 billion has been pulled from equity markets, as reported by Economic Times. This data highlights the significant shift in foreign investment patterns toward government securities amid current market conditions. The rupee has faced significant pressure, losing over 5% and the 10-year yield gaining 34 basis points since the U.S.-Israeli war on Iran began on February 28. The currency has declined more than 6 per cent against the dollar so far this year, making it the second-worst performing currency in Asia. The rupee hit an all-time low of 96.9650 on May 20 before recovering somewhat on the back of RBI intervention and softer crude oil prices. The currency closed 0.5% lower to 95.71 per dollar on Wednesday, while the 10-year yield rose 1 basis point to 7.02%. Market participants see the proposal as part of a broader effort to make Indian debt markets more competitive globally, with S.R. Patnaik from Cyril Amarchand Mangaldas noting that the removal of the 12.5 per cent capital gains tax substantially reduces the cost of investment for foreign portfolio investors.
Legal and market experts view the tax reform as transformative for India's debt market competitiveness. Diviay Chadha from Singhania & Co. stated that the move could be transformative for India's debt markets, as "for years, tax friction has made foreign funds think twice before choosing Indian bonds over other emerging markets. Cutting or removing this tax could trigger a wave of FPI inflows, inject much-needed liquidity into the bond market, and give the rupee a solid boost." The reform aligns with India's broader ambition of integrating its debt market with global capital pools, with the government and Reserve Bank of India having introduced the Fully Accessible Route (FAR) and eased investment restrictions, helping Indian government securities gain inclusion in major global bond indices such as the J.P. Morgan Emerging Market Bond Index and Bloomberg's emerging market local currency bond index. The proposed tax relief could have implications beyond immediate capital flows, with greater foreign participation expected to deepen liquidity, diversify the investor base beyond domestic banks, improve price discovery and potentially lower borrowing costs for the government over time. However, there are questions around the fiscal cost of the measure, with policymakers betting that stronger capital inflows, a more stable currency and a deeper bond market will outweigh the near-term revenue sacrifice.
