The Indian government on Friday promulgated an ordinance to exempt capital gains tax on investments made by Foreign Institutional Investors (FIIs) in government securities, according to a PTI report. The move is aimed at attracting foreign capital and making Indian debt markets more attractive to overseas investors, while also helping shield the economy from the effects of the continuing Iran conflict.
Cabinet Approval and Legislative Amendment
The Union Cabinet, chaired by Prime Minister Narendra Modi, approved an ordinance on Wednesday to amend the Income Tax Act and facilitate the proposed exemption. This legislative action underscores the government's commitment to liberalizing the financial sector and enhancing India's appeal as an investment destination.
Current Tax Regime for Foreign Investors
Currently, foreign investors are subject to a 12.5% long-term capital gains tax on listed equities and bonds held for more than one year. Interest earned on government securities is also taxed through a 20% withholding levy. A concessional 5% tax rate that was previously available to foreign investors was withdrawn in 2023, making the new exemption a significant policy reversal.
Broader Context: Foreign Fund Outflows and Rupee Pressure
The proposals come against a backdrop of sustained foreign fund outflows, with market participants repeatedly calling for lower long-term capital gains tax rates and reduced withholding taxes on interest income from government securities. The timing is significant, as foreign portfolio investment (FPI) flows have remained negative while the rupee has faced considerable pressure against the US dollar amid the continuing conflict in West Asia.
Since the start of the current calendar year, net FPI outflows have reached Rs 2.47 lakh crore, more than double the Rs 1.04 lakh crore withdrawn during calendar year 2025. This trend has been a major concern for policymakers, as it affects liquidity and currency stability.
Rupee Recovery and Market Dynamics
The rupee had weakened to a record low of 96.965 against the dollar on May 20 before recovering partially. The recovery was aided by RBI intervention and softer crude oil prices following renewed diplomatic efforts between the US and Iran. The government's latest move is expected to further stabilize the currency by attracting foreign capital inflows.
Expected Further Initiatives
The government is also expected to introduce further initiatives designed to encourage overseas capital inflows. These may include additional tax incentives, regulatory simplifications, and measures to deepen the bond market. The aim is to create a more favorable investment climate and reduce dependence on volatile foreign portfolio flows.
Market Reaction and Future Outlook
Market participants have welcomed the ordinance, with many expecting it to boost FII participation in government securities. The exemption is likely to lower borrowing costs for the government and improve liquidity in the debt market. However, analysts caution that sustained capital inflows will also depend on global risk appetite and domestic economic fundamentals.
This story is being updated as more details emerge.
