How India Is Using Tax Breaks to Attract Foreign Investors and Support the Rupee
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By Pranjal Gupta
New Delhi, June 5: In a major policy shift aimed at attracting foreign money into the country, the Centre has removed capital gains tax and interest income tax on government bonds held by Foreign Institutional Investors (FIIs). The move comes at a time when policymakers are trying to strengthen the rupee and reduce pressure on India's external finances.
The changes were introduced through an ordinance after receiving approval from President Droupadi Murmu and will take effect from 1 April 2026. "The exemption shall be applicable w.e.f. 01.04.2026, i.e. the exemption shall apply to any interest or capital gains arising to FPIs on or after 01.04.2026 in respect of investments in G-Secs," said the Ministry of Finance in an official statement.
Why Has the Government Taken This Step?
The decision comes amid concerns that India could face a significant Balance of Payments (BoP) deficit in the 2026-27 financial year. Economists estimate the deficit could reach as much as $60 billion.
A Balance of Payments deficit occurs when a country spends more foreign currency than it earns through exports, investments and remittances. When this happens, demand for foreign currency rises, putting pressure on the local currency.
For India, this means the rupee could weaken further unless additional foreign money flows into the country.
The rupee has already faced considerable pressure in recent months. Since the outbreak of the Iran conflict in February, the currency has fallen around 5 per cent against the US dollar.
Over the past year, it has lost more than 10 per cent of its value.
By making government bonds more attractive to overseas investors, the government hopes to bring in fresh foreign capital, support the rupee and reduce pressure on the country's external accounts.
What Taxes Have Been Removed?
Under the new rules, foreign investors will no longer pay tax on:
Interest earned from Indian government bonds.
Long-term capital gains made from selling government bonds.
Short-term capital gains arising from the transfer of government bonds.
The exemption also applies to the Bank for International Settlements (BIS), an organisation owned by central banks from around the world.
Why Were Foreign Investors Unhappy?
Many international investors considered India's tax treatment of government bonds less attractive than that of competing markets.
The situation was especially difficult for investors from countries that did not have favourable tax treaties with India. They often faced higher tax costs and could not offset losses against previous gains.
As a result, several global investors preferred to invest in other emerging markets where tax rules were simpler and returns were higher.
RBI Also Announces Additional Reforms
Alongside the government's tax changes, the Reserve Bank of India (RBI) announced measures designed to make Indian government bonds more accessible to foreign investors.
The ministry also decided to expand the Fully Accessible Route (FAR), a framework that allows foreign investors to buy certain government securities without investment limits.
The RBI will now include all newly issued 15-year, 30-year and 40-year government bonds under this route.
In addition, the central bank has removed several restrictions on foreign portfolio investment in government securities, including limits on short-term investments and concentration rules.
Together, these measures are intended to increase foreign participation in India's bond market and make it easier for the government to finance its borrowing requirements.
Will the Move Help India?
The government's strategy is straightforward: make Indian government bonds more attractive, bring in more foreign money and reduce pressure on the rupee.
If foreign investors increase their purchases of government bonds, India could receive billions of dollars in fresh capital inflows. This would help finance the country's external deficit, improve foreign exchange reserves and support the value of the rupee.
However, the success of the policy will depend on broader global conditions, investor confidence and developments in international markets. Tax incentives may encourage investment, but investors will also consider factors such as economic growth, inflation, geopolitical risks and currency stability before committing funds.
For now, the government's message is clear: India is willing to offer significant tax benefits to attract overseas capital at a time when the economy needs stronger foreign inflows.
