The Indian government is contemplating significant changes to its tax structure in an effort to make the country’s bond market more appealing to foreign investors. This decision arises during a period when the rupee is under severe pressure, and overseas investments in domestic equities have been retreating. According to a report by The Economic Times, these measures aim to entice foreign portfolio investors (FPIs) back into the Indian market.

One of the key proposals includes the potential scrapping of capital gains tax on investments in government securities. Additionally, the government is reviewing current ownership restrictions on certain sovereign bonds, aiming to facilitate greater foreign investment in these assets. This strategic shift occurs against a backdrop of record outflows from Indian equities and a struggling rupee.

With increasing crude oil prices, largely driven by geopolitical tensions, the government aims to reverse the trend of foreign fund outflows. Notably, over the past year, FPIs have withdrawn close to $28 billion from Indian equities, while simultaneously investing a net $1.4 billion in government bonds.

Reasons Behind The Proposed Tax Changes

The focus on reforming tax policies seems rooted in the need to stabilise India’s financial markets and strengthen the rupee, which recently hit 96.9650 against the US dollar. This marked a record low before a slight recovery was observed. Various factors have been identified as contributors to the rupee’s depreciation, including rising import costs for oil, significant outflows from foreign investors, and global trade uncertainties.

Data indicate that the Indian rupee is among the poorest performers in Asia this year, having depreciated by over 6 per cent against the dollar. Recognising this challenge, the authorities are exploring reforms to attract capital inflows and support currency stability.

Reports suggest that the Union Cabinet has taken a significant step by approving the proposal to eliminate capital gains tax on foreign portfolio investments in government bonds. As it stands, foreign investors face a 12.5 per cent long-term capital gains tax on shares and bonds held for over a year. Furthermore, discussions are ongoing about the possibility of reducing the 20 per cent withholding tax on interest earned from government securities.

Potential Changes From The Reserve Bank Of India

The Reserve Bank of India (RBI) may also introduce additional measures to complement the proposed tax reforms. The RBI is reportedly contemplating the designation of more long-term government securities under the Fully Accessible Route (FAR), which would allow foreign investors to purchase these bonds without restrictions. Such a move could significantly ease access for global funds to the Indian debt market.

Prior to this, changes within this framework occurred in 2024, when the list of eligible government securities was revised. The removal of investment limits could enhance foreign participation in Indian debt, contributing to market depth and liquidity.

Market analysts believe that these strategic reforms have the potential to attract a larger share of global fixed-income investments into India. An increase in foreign investment in government bonds could alleviate pressure on the rupee and provide a necessary boost to the country’s external accounts. As India grapples with substantial foreign selling in equities and high energy costs, these proposed measures could help fortify its bond market.

Implications For Foreign Investment Strategies

The government is also reportedly considering plans that would allow Persons Resident Outside India (PROIs) to invest in shares of listed Indian companies via the portfolio investment scheme. Such initiatives would broaden the range of opportunities available to foreign investors and support capital inflows into Indian financial markets.

While no formal announcement has yet been made from the Finance Ministry or the RBI, these proposed tax reforms and market accessibility enhancements are being closely monitored by investors. If realised, these changes could represent one of the most significant attempts in recent years to attract foreign capital into India’s bond market while strengthening support for the rupee.

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