Centre Considers Tax Exemption For FPIs Investing In Government Bonds

The government is planning to remove capital gains tax on foreign portfolio investments (FPIs) in government securities, a move aimed at attracting more overseas funds into the domestic debt market.

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The cabinet approved the proposal, which is expected to make Indian government bonds attractive for foreign investors. An official announcement on the implementation timeline is awaited.

Proposed Changes For Foreign Investors

Currently, foreign investors pay a long-term capital gains tax of 12.5% on listed shares and bonds held for more than 12 months. The proposed change would eliminate this tax for investments in government securities.

The government is also considering removing the 20% withholding tax levied on interest income earned by foreign investors from government bonds, according to a person familiar with the matter cited in reports. If implemented, both measures would reduce the tax burden on overseas investors participating in India's sovereign debt market.

Focus On Attracting Overseas Capital

The move comes as policymakers seek to increase foreign capital inflows into debt markets at a time when the Indian rupee has faced pressure against the U.S. dollar. The rupee has declined by more than 5% since the beginning of the year, influenced by higher crude oil prices and sustained foreign portfolio outflows from equities.

Foreign investors have withdrawn nearly $28 billion from Indian equity markets so far this year. In contrast, government securities have continued to attract overseas interest, recording net inflows of about $1.4 billion, according to available market data.

Bond Market Reacts

Indian government bonds saw a modest reaction after reports of the proposed tax changes emerged. The yield on the benchmark 10-year government bond eased by one basis point to 7.01% in early trade.
Lower yields generally indicate increased demand for bonds, although market participants are awaiting formal details of the proposed tax framework before assessing its broader impact.

Debt Market Could Gain From Tax Alignment

India's taxation for foreign equity investors is pretty similar to what other countries do. Still, many big financial centers don't tax non-residents' investments in government debt like India does now. Introducing an exemption would bring India's rules more in line with others around the world and could make its government securities more appealing to long-term foreign investors. 

Given that overseas investors keep putting money into Indian sovereign debt, even when equity markets are shaky, these tax changes could really boost the government's goal of increasing foreign involvement in the bond market and bring more capital into the economy too.