Why is India cutting tax burden for foreign investors? – Firstpost

The Union Cabinet, chaired by Prime Minister Narendra Modi, has reportedly approved an ordinance that would remove capital gains tax on investments made by foreign portfolio investors (FPIs) in Indian government securities.

Sources have indicated to Reuters that the government is examining the possibility of eliminating or sharply reducing the 20 per cent withholding tax levied on interest income earned by foreign investors from these bonds.

The Economic Times was the first to report
Wednesday’s cabinet approval of the plan.

The move comes at a time when policymakers are attempting to insulate the Indian economy from the ripple effects of the ongoing war in West Asia. The conflict has rattled energy markets making the challenge for India especially acute.

The country remains heavily dependent on imported crude oil, its currency has weakened substantially this year and foreign investors have withdrawn large sums from domestic equities.

Why has the govt decided to focus on foreign capital?

At the centre of the decision is the impact of the Iran war on global energy markets. The conflict has heightened concerns regarding supply disruptions
in the Strait of Hormuz, one of the world’s most important energy transit routes.

India imports more than 80 per cent of its crude oil requirements. As a result, any disruption in global oil supplies or sustained increase in energy prices has a direct impact on the country’s trade balance, inflation outlook and currency stability.

Brent crude prices, which had been trading near the $70-per-barrel mark, have climbed sharply and moved into a range of approximately $95 to $105 per barrel. For a country that relies heavily on imported energy, such a rise translates into a significantly larger import bill.

Higher oil costs require larger dollar payments to overseas suppliers. This increases demand for the US currency and places additional strain on the rupee.

At the same time, expensive energy imports widen the current account deficit and increase pressure on foreign exchange reserves.

How has the rupee been affected?

According to recent data, the rupee has weakened by more than 5 per cent since the beginning of the year.

Other estimates indicate that the decline has exceeded 6 per cent during 2026. The currency touched a record low of 96.965 against the US dollar on May 20.

A weaker rupee creates challenges on multiple fronts.

First, it increases the cost of imports, particularly crude oil. Second, it raises the rupee value of external obligations. Third, it affects foreign investor sentiment because overseas investors ultimately evaluate returns in dollar terms.

Even if an investor earns gains in India, a sharply depreciating currency can erode those returns when converted back into dollars. This can discourage foreign investment and create a feedback loop in which capital outflows contribute to further currency weakness.

The Reserve Bank of India
has intervened in the foreign exchange market to support the rupee, but attracting additional foreign capital remains a critical part of the broader strategy to maintain stability.

Why are foreign investors pulling money out of India?

Foreign portfolio investors have withdrawn nearly Rs 2.5 lakh crore from Indian equities during 2026 so far. Some estimates place the figure at approximately Rs 2.47 lakh crore.

The scale of the outflows becomes even more striking when compared with previous years.

Throughout the entirety of 2025, foreign investors withdrew around Rs 1.04 lakh crore from Indian equities. In contrast, the exits recorded during just the first few months of 2026 are more than double that amount.

March proved particularly significant. During that month alone, foreign investors reportedly sold Indian equities worth around Rs 1.17 lakh crore, making it one of the largest monthly withdrawals on record.

The selling pressure contributed to India’s net foreign investment balance slipping into negative territory, with a deficit of approximately $11.7 billion recorded during March.

Several factors have contributed to this trend. The first is heightened global uncertainty arising from geopolitical tensions.

The second is a broader shift in international investor preferences. Strong technology and
artificial intelligence-related rallies in markets such as South Korea and Taiwan have attracted substantial global capital, leading some investors to reduce exposure to Indian equities.

The third factor is the weakening rupee, which diminishes the attractiveness of returns for overseas funds.

Why is the govt betting on foreign bond investors?

While foreign investors have been reducing exposure to equities, their behaviour in the debt market has been markedly different. Data shows that overseas investors have remained net buyers of Indian government securities during 2026.

Net inflows into government debt have reached approximately $1.4 billion this year despite the broader uncertainty.

This contrast has not gone unnoticed by policymakers. Government bonds are often viewed as comparatively safer investments during periods of geopolitical instability and financial market volatility.

Investors seeking predictable returns and lower risk frequently increase exposure to sovereign debt when uncertainty rises. The government’s latest tax initiative is designed to capitalise on this trend.

By reducing the tax burden associated with investing in Indian government securities, policymakers hope to make these instruments even more attractive to global funds, pension managers, insurance companies and other long-term institutional investors.

The strategy is not simply about attracting money. It is also about attracting a specific kind of money — capital that is generally more stable and less prone to sudden exits than investments in equities.

At present, foreign investors are subject to multiple tax obligations when investing in Indian debt instruments. A long-term capital gains tax of 12.5 per cent applies to listed shares and bonds that are held for more than 12 months.

In addition, foreign investors pay a 20 per cent withholding tax on interest earned from government securities. Sources indicate that both of these tax burdens could be significantly reduced under the new framework.

If implemented, these changes would substantially improve post-tax returns for overseas investors.

One source familiar with the matter told Reuters that while India’s taxation of equity investments is broadly aligned with international norms, the country remains among the relatively small group of nations that continue to tax non-resident investments in debt markets.

The timing of implementation remains unclear. However, the measure should take effect after receiving Presidential approval.

What next for India’s economic strategy?

As oil prices rise and pressure on the rupee increases, attracting foreign investment into government debt can provide multiple benefits.

Such inflows can help support foreign exchange reserves and ease pressure on the currency. They can also assist the government in financing its borrowing requirements without relying excessively on domestic sources of capital.

Reports have also suggested that the RBI
may complement the government’s initiative through regulatory changes.

One possibility is expanding access to designated sovereign securities through the Fully Accessible Route, allowing overseas investors to purchase certain long-duration government bonds without regulatory caps.

The market response to reports of the tax proposal was largely positive. India’s benchmark government bond yield eased by one basis point to around 7.01 per cent in early trading after news of the cabinet approval emerged.

With inputs from agencies