India eyes tax overhaul to attract foreign money into bond market

India plans to scrap capital gains tax on foreign portfolio investor holdings of government securities, the Economic Times reported on Thursday.

The proposed move is aimed at attracting overseas capital at a time when the rupee is under pressure.

As per the report, a cabinet meeting on Wednesday approved the measure and the change is likely to be implemented through an ordinance amending Income Tax rules.

If enacted, the measure would mark a significant shift in the tax treatment of foreign investment in India’s sovereign debt market, potentially improving post-tax returns for global funds that hold government securities.

What is being proposed

The plan would remove capital gains tax on foreign portfolio investment in government bonds.

Foreign investors currently pay a 12.5% long-term capital gains tax on listed shares and bonds held for more than 12 months.

Removing that levy for holdings of government securities would lower the tax cost for overseas investors and make Indian sovereign debt more competitive relative to other emerging-market assets.

The report also said the government may remove the 20% withholding tax on interest earned from government bonds.

That would represent a broader effort to improve returns for foreign portfolio investors, not just on price gains but also on coupon income.

The final scope of the measure remains unclear.

Why the change matters

The reported proposal comes as policymakers look for ways to attract more stable foreign capital into India’s debt market.

Foreign participation in government bonds can support demand for sovereign securities, deepen market liquidity and help broaden the investor base.

For overseas funds, tax treatment is a key factor in allocation decisions, particularly when comparing local-currency bonds across emerging markets.

Lowering or removing taxes on gains and interest could increase net returns for foreign investors.

That, in turn, may make Indian government securities more attractive at a time when global funds are weighing currency risk, interest-rate expectations and relative yields.

The move would also come against the backdrop of pressure on the rupee.

Stronger foreign inflows into government debt could offer some support to the currency, although the eventual impact would depend on the scale of participation and broader global market conditions.

Where foreign flows stand

Foreign investors have been net buyers of Indian government debt this year, investing a net $1.4 billion.

That contrasts sharply with equity market flows. Overseas investors have pulled nearly $28 billion from Indian stocks over the same period.

The divergence highlights why the government may be focusing on the bond market. While equities have faced sustained foreign outflows, government securities have continued to draw some overseas demand.

A tax break could help strengthen that trend and offset pressure elsewhere in the capital account.

The reported policy move also comes after India’s inclusion in major global bond indexes, which has already increased international attention on its sovereign debt market.

Tax clarity and lower friction costs could further improve the appeal of Indian bonds for passive and active foreign investors.

How the measure may be implemented

The decision is likely to be implemented through an ordinance amending Income Tax rules.

An ordinance route would allow the government to move quickly, though the details would matter.

Investors will watch whether the exemption applies only to future investments or also to existing holdings, whether it covers all government securities or only certain eligible instruments, and whether the interest withholding tax is removed alongside the capital gains levy.

Clarity will also be needed on the effective date, compliance requirements and treatment of different categories of foreign portfolio investors.

Until the ordinance is published, the measure remains a reported policy plan rather than a confirmed rule change.