India Scraps Capital Gains Tax on Foreign Bond Investors

In a move aimed at attracting foreign capital and stabilizing the rupee, India has approved a plan to scrap the long-term capital gains tax on foreign portfolio investments in government securities. The decision, reported by the Economic Times and confirmed by a source familiar with the matter, could significantly boost inflows into Indian debt markets.

Tax Relief to Lure Foreign Investors

Currently, foreign investors are subject to a 12.5% long-term capital gains tax on listed shares and bonds held for more than 12 months. Additionally, a 20% withholding tax on interest earned from government bonds may also be removed under the new plan. The source, who requested anonymity due to the confidential nature of the decision, noted that India stands out among global peers by taxing non-resident debt flows, and this change would align the country with international standards.

Impact on the Rupee and Bond Yields

The rupee has weakened more than 5% since the start of 2026, pressured by higher oil prices and sustained foreign portfolio outflows from equities. In contrast, foreign investors have maintained net positive flows into Indian government debt, investing $1.4 billion this year. However, nearly $28 billion has been pulled from equity markets, exacerbating currency pressure. The tax exemption is expected to encourage more foreign investment in bonds, providing support for the rupee and potentially lowering bond yields. India's benchmark bond yield eased one basis point to 7.01% in early trading following the announcement.

Market and Regulatory Context

The cabinet approval, reported on Wednesday, marks a significant policy shift. The finance ministry has not yet commented on the timeline for implementation. Analysts view this as a strategic move to deepen the government securities market and attract a broader investor base, especially as India's weight in global bond indices increases. The removal of the withholding tax could also enhance the attractiveness of Indian bonds relative to other emerging markets.

Broader Implications

This tax reform is part of a broader effort to liberalize capital markets and integrate India into the global financial system. By reducing the tax burden on foreign debt investors, India aims to offset equity outflows and stabilize its currency. The move could also help finance the government's borrowing program at lower costs. However, the success of the policy will depend on other factors, including global interest rate trends and domestic inflation.

Key Takeaways

1. India plans to scrap long-term capital gains tax on foreign portfolio investments in government securities.
2. The withholding tax on interest from government bonds may also be removed.
3. The move aims to attract foreign capital to support the rupee, which has weakened over 5% in 2026.
4. Foreign investors have invested $1.4 billion in Indian government debt this year but pulled $28 billion from equities.
5. The benchmark bond yield eased 1 basis point to 7.01% following the news.

Sources: CNBC, Reuters