India Abolishes Capital Gains Tax on Foreign Investments in Govt Bonds

In a significant move to bolster foreign investment and stabilize the Indian rupee, India has abolished the capital gains tax and withholding tax on interest income for foreign portfolio investors (FPIs) and the Bank for International Settlements (BIS) investing in government securities. The reform, enacted through the Income-tax (Amendment) Ordinance, 2026, is effective retrospectively from April 1, 2026. Previously, foreign investors faced a 12.5% long-term capital gains tax on bonds held for over 12 months and a 20% withholding tax on interest earned from government bonds. This tax exemption effectively reduces the tax rate to zero for eligible foreign investors, aiming to significantly improve their post-tax returns and make Indian government debt more competitive on the global stage. The decision comes at a time when the Indian rupee has experienced significant depreciation, weakening by over 5% against the US dollar since the beginning of the year, largely due to rising oil prices and substantial outflows from the equity market. In 2026, foreign investors pulled approximately INR 2.6 trillion from Indian equities, a figure already exceeding the INR 1.66 trillion withdrawn in all of 2025. Concurrently, Indian government bonds saw net inflows of around USD 1.4 billion in the same period. By removing these tax barriers, India seeks to attract more stable, long-term foreign capital, thereby supporting the rupee and strengthening the country's external financing position. The government's initiative is complemented by a series of other measures aimed at making India's debt market more accessible and appealing to foreign investors. The Reserve Bank of India (RBI) has relaxed various investment norms for FPIs, including expanding the Fully Accessible Route (FAR) to include longer-dated securities and Sovereign Green Bonds, and removing security-specific investment caps, short-term investment limits, and concentration limits under the General Route. These reforms are part of a broader strategy to enhance the depth, liquidity, and attractiveness of India's bond market, aligning it more closely with global best practices and potentially paving the way for inclusion in major global bond indices. Such inclusion could lead to substantial passive fund inflows into Indian government debt. While the move is widely seen as positive for attracting foreign capital and supporting the rupee, some analysts caution that it may not be an immediate 'magic bullet' for the economy. However, it is expected to provide a sustained boost to foreign capital inflows and improve the overall investment climate in the medium term. The government's rationale behind these changes is to simplify the tax structure, make Indian assets more competitive, and attract stable, patient foreign capital, including from institutional investors like pension funds and sovereign wealth funds. The Finance Ministry did not immediately respond to Reuters' requests for comment when the initial reports emerged, but the subsequent official announcement via an ordinance confirmed the policy change. The broader implications for the Indian economy include a potential reduction in government borrowing costs over time and an improvement in the country's foreign exchange reserves. This strategic fiscal move underscores India's commitment to integrating its financial markets globally and enhancing its appeal as an investment destination. In related tax reforms, India's Union Budget 2024-25 introduced significant changes to capital gains taxation for domestic investors, rationalizing rates and simplifying holding periods. However, these domestic changes are distinct from the specific tax exemption provided to foreign investors for government bonds.

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