The Indian government is actively reviewing its capital market tax structure, specifically focusing on the long-term capital gains (LTCG) tax and Securities Transaction Tax (STT), in anticipation of Budget 2027. This comes amidst significant foreign portfolio investor (FPI) outflows, totaling ₹3.07 lakh crore from Indian equities in 2026 alone.
Government Consults on Tax Reforms
Finance Minister Nirmala Sitharaman has acknowledged the ongoing debate surrounding these levies, noting frequent discussions with both domestic and global investors. Reports indicate that consultations with market participants, intermediaries, and tax experts have begun to reassess the current tax regime, which includes a 12.5% LTCG tax on eligible equity gains exceeding ₹1.25 lakh annually, alongside STT.
Why the Urgency?
The urgency for review is underscored by several factors: Indian stocks have underperformed global peers, with the benchmark Nifty 50 declining 13.1% year-to-date as of late October. Concurrently, the rupee has depreciated 5.58% against the US dollar, diminishing dollar-denominated returns for foreign investors. These conditions, combined with substantial FPI selling—totaling an estimated ₹3.51 lakh crore between 2021 and September 2026—have fueled calls for a more competitive tax environment.
Experts Weigh In on LTCG Tax Impact
Market analysts and economists offer varied perspectives on the potential effectiveness of an LTCG tax reduction. While some believe easing the tax burden could enhance India's attractiveness, others caution that tax is just one of many influencing factors.
- SBI Research has advocated for abolishing the LTCG tax on equities entirely, suggesting an extension of the qualifying holding period to two or three years from the current one. This aims to foster longer-term foreign investment over short-term speculative flows.
- Madan Sabnavis, chief economist at Bank of Baroda, highlighted the direct correlation: “The common factor is FPI selling affecting indices and currency. Earnings have only improved recently.”
Compared to other major markets like Taiwan (gained 59%), South Korea (29.8%), Japan (23.5%), and the US S&P 500 (11.4%), India's Nifty 50 performance stands out as one of the weakest globally.
Beyond Taxation: Other Influencing Factors
A reduction in LTCG tax, while potentially beneficial, may not be sufficient on its own to reverse the significant FPI outflows. Several other global and domestic factors heavily influence foreign investment decisions:
- Relative Valuations: Despite a decline, India's Nifty price-to-earnings ratio of 20.4 remains higher than some major markets, including Japan (19.9).
- Global Interest Rates: Higher US Treasury yields have made dollar-denominated assets more appealing, drawing capital away from emerging markets.
- Technological Rallies: The artificial intelligence-led rally has diverted significant capital towards markets in Taiwan and South Korea, which are perceived to offer higher growth prospects in tech.
- Currency Movements: The depreciating rupee erodes returns for foreign investors, impacting their overall profitability.
- Corporate Earnings: Strong and consistent corporate earnings growth remains a crucial determinant for attracting sustained foreign capital.
Government's Fiscal Dilemma
The government faces a delicate balancing act. While reducing capital market taxes could boost competitiveness and attract foreign capital, it also involves a potential loss of significant revenue. LTCG collections reached ₹1.29 lakh crore in FY25, up from ₹72,249 crore in FY24, while STT collections hit ₹57,522 crore in FY26. Any tax relief in Budget 2027 would need to carefully weigh the benefits of increased foreign investment against the fiscal implications.
Ultimately, while tax reforms could remove a key barrier for investors, the return of substantial foreign capital will also depend on India offering competitive valuations, stronger earnings prospects, and attractive returns adjusted for currency fluctuations.