In a significant policy shift, the Indian government has issued an Ordinance on May 5, exempting foreign institutional investors (FIIs) from paying income tax on capital gains or interest earned from investments in Government Securities (G-Secs). This exemption, which comes into effect from April 1, 2026, is designed to attract stable and long-term capital flows into the country's debt market.
Boosting Capital Inflows and Government Spending
Official sources indicate that the move will provide a more stable source of capital, crucial for supporting government spending in vital sectors such as infrastructure, urbanization, climate transition, manufacturing, and social sector development. Currently, FIIs face a 12.5% tax on capital gains and a 20% withholding tax on interest from G-Secs, which has historically made Indian markets less competitive compared to global peers.
The Centre's decision, alongside measures from the Reserve Bank of India, aims to enhance the appeal of India's debt market. Greater foreign participation is expected to improve liquidity and price discovery in the G-Sec market, strengthening interest rate signaling and reducing the government's borrowing costs by compressing term premia.
Streamlining Investment and Global Integration
Experts laud the tax exemption for not only improving post-tax yields but also for streamlining investment processes. Sunil Gidwani, Partner at Nangia Global Advisors, noted that the measure addresses a long-standing friction, making Indian sovereign debt more competitive. “Beyond improving post-tax yields, the measure facilitates seamless index investing, Euroclear-style settlement structures and offshore portfolio rebalancing,” Gidwani stated, anticipating a broader investor base including pension funds and sovereign wealth funds.
Nehal Sampat, Partner at Price Waterhouse & Co, highlighted that the exemption should simplify investment norms for FPIs, potentially removing the need for them to file tax returns or manage withholding tax deductions. This reduction in 'friction' could also assist in the greater inclusion of Indian government securities in global bond indices, triggering increased inflows into India.
No Relief for Equity Investments
While the Ordinance marks a major step for the debt market, it does not extend similar tax relief to foreign investment in listed equities. Sachin Sawrikar, Founder and Managing Partner of Artha Bharat Investment Managers, acknowledged the positive impact on G-Secs but pointed out that the core concerns of long-only equity investors regarding capital gains structure, currency risk, and valuation premiums remain unaddressed. “The real ask from foreign investors has always been on equities,” Sawrikar noted, indicating a continued industry hope for future review of equity taxation.