In a major policy move to attract foreign capital into India’s debt market, the Union Cabinet approved the removal of capital gains tax on investments made by FPIs in Indian government securities (G-Secs) across all maturities. This will help make Indian sovereign bonds attractive to global investors and increase foreign participation in the country’s debt market.
The change is expected to come through an ordinance that will extend tax laws to foreign investment in government securities. This is the policy that is expected to help to push overseas capital to the country, keep the Indian rupee strong and deepen the domestic bond market in the world economy.
Tax relief for Foreign Investors
Under the current tax framework, foreign investors are required to pay a 12.5% long-term capital gains tax on listed bonds held for more than 12 months. The new policy will eliminate capital gains tax on investments made by foreign institutional investors in Indian government securities.
In another major relief measure, the government has also decided to abolish the 20% withholding tax on interest income earned by foreign investors from government bonds. So foreign investors will be able to retain a larger proportion of their returns, which will increase the attractiveness of Indian debt instruments.
The dual tax exemptions are expected to put Indian government bonds on a better footing when compared to sovereign debt instruments offered by other emerging market economies.
Why did the government take this step?
The decision came against the background of huge foreign capital outflows from Indian financial markets. According to market data, foreign portfolio investors have withdrawn nearly Rs 2.2 lakh crore of money from Indian markets so far this year, compared to around Rs 1.6 lakh crore in the previous year.
The outflows have put pressure on the Indian rupee and contributed to volatility in financial markets. Rising global crude oil prices have only aggravated fears, as India still depends on imported energy.
By offering tax-free returns on government bond investments, policymakers hope to stimulate foreign capital into the debt market, relieve a lot of the pressure on the stock market from equity outflows and support external financial stability.
What will be the impact on the bond market?
Market analysts say that the move would boost the demand for Indian government securities for global institutional investors, sovereign wealth funds, pension funds, and international asset managers.
Higher foreign investment in government bonds can improve liquidity in the debt market and might, in the long run, lower borrowing costs for the government. There will also be more stable bond yields due to increased demand for the country’s fiscal financing needs and hence more stable bond yields.
But the decision is especially timely as India is integrating more closely with international financial markets after the inclusion of Indian government bonds in the largest international bond indices.
Boost for India's Investment Appeal
The removal of capital gains tax and withholding tax is a strong signal of India's determination to create an investor-friendly environment. The reforms are expected to enhance the country's attractiveness as an investment destination and strengthen its position in the global fixed-income market.
Economists say the move may be good for long-term foreign money inflow, global investors’ confidence and the larger objective of maintaining macroeconomic stability in a context of global uncertainty, especially the stability of the economy.
When the ordinance is implemented, the effect of the ordinance will be closely watched by investors and market players to see the impact on foreign investment flows, bond yields, and the overall performance of India's debt market. The government’s move on long-term global funding will be watched closely for its effect on foreign investment flows, bond yields, and the overall performance of the Indian debt market and Indian economy.
