In a significant push to bolster foreign capital inflows, India's Union Cabinet, led by Prime Minister Narendra Modi, has approved an ordinance to remove capital gains tax on investments in government securities (G-Secs) by foreign portfolio investors (FPIs). This decision aims to stabilize the economy against the backdrop of the West Asia conflict and recent negative foreign capital flows.
The ordinance will amend the Income Tax Act, with a formal notification expected once the President grants assent. This tax relief comes after persistent requests from the industry to reduce long-term capital gains (LTCG) and withholding taxes on government bond investments.
Current Tax Regime for Foreign Investors
Currently, foreign investors are subject to a 12.5% long-term capital gains tax on listed shares and bonds held for over 12 months. Additionally, they face a 20% withholding tax on interest earned from government bonds. The government had previously removed a concessional 5% withholding tax rate for these investors in 2023, making the current move a notable reversal in policy aimed at making Indian markets more attractive.
Addressing FPI Outflows and Rupee Weakness
The decision to remove the capital gains tax is a direct response to a challenging economic environment. Foreign portfolio flows have turned negative, and the Indian rupee has weakened significantly against the US dollar. So far this year, FPIs have recorded net outflows totaling ₹2.47 lakh crore, more than double the ₹1.04 lakh crore withdrawn in the previous year.
The rupee hit a record low of 96.965 against the dollar on May 20, though it has since recovered slightly due to interventions by the Reserve Bank of India and easing oil prices following renewed US-Iran peace talks. The government hopes this tax exemption, alongside other anticipated measures, will reverse the trend of outflows and strengthen the domestic currency.
Precedent and Future Outlook
The government has utilized the ordinance route in the past, notably in 2019, to cut corporate tax rates to encourage private investment. This latest use of an ordinance underscores the urgency placed on attracting foreign capital amidst current global and regional economic pressures.
Regulators are expected to introduce further measures to support the government's efforts, enhancing the appeal of Indian markets to overseas investors. The move is anticipated to make Indian G-Secs more competitive globally and provide a much-needed boost to the nation's financial stability.