Are Tax Tweaks Enough to Stem the Foreign Investment Outflows?

India has rolled out a slew of measures to attract foreign capital into local debt markets and support the depreciating rupee. In a coordinated move, the Reserve Bank of India and the central government announced some relaxations for foreign investors. 

The government has removed capital gains and withholding taxes on FPI investments in government securities (G-sec), while the central bank has eased investment norms along with expanding access to sovereign bonds. 

The measures come at a time when foreign investors have been steadily pulling money out of Indian markets. As per data, foreign investors withdrew ₹27,048 crore in May, indicating cautiousness among global investors amid an evolving global macroeconomic and geopolitical environment.

With this, total outflows by FPIs from the equity market have reached ₹2.2 lakh crore in 2026, higher than the ₹1.66 lakh crore pulled out during the entire 2025.

At the same time, policymakers are also trying to navigate a difficult global environment. On June 5, the RBI’s Monetary Policy Committee (MPC) kept the benchmark repo rate unchanged at 5.25%, but also lowered its FY27 growth forecast to 6.6% from 6.9%. 

While raising the inflation projection to 5.1% from 4.6%, governor Sanjay Malhotra cited heightened uncertainty stemming from geopolitical tensions in West Asia and increased crude oil prices as key risks.

India’s New Deal for FPIs

Among the key steps, the RBI announced the expansion of the Fully Accessible Route (FAR), under which foreign investors can invest in specified government securities without being subject to investment caps. It has brought all newly issued 15-year, 30-year and 40-year government bonds under the FAR route. 

In addition, sovereign green bonds have been included in the FAR basket, widening the pool of debt instruments available to overseas investors. These instruments are used to help finance the government's budget deficit.

On the regulatory front, the RBI has scrapped several sub-limits that previously governed FPI investments through the general route, including restrictions linked to short-term holdings, concentration levels and exposure to individual securities. However, the overall investment caps remain unchanged at 6% of outstanding central government securities and 2% of state government securities.

The central bank has also simplified the investment framework by merging the existing 'general' and 'long-term' categories for FPI investments into a single bucket for both central and state government bonds. 

The government, meanwhile, has offered a significant tax sweetener. From April 1, 2026, FPIs will no longer have to pay tax on interest income or capital gains earned from investments in government securities. The exemption covers both short-term and long-term gains. The same tax treatment has also been extended to the Bank for International Settlements (BIS).

The government has also expanded the Portfolio Investment Scheme to include individual Persons Resident Outside India (PROIs), while doubling the per-company investment limit to 10% and raising the aggregate cap for all such investors to 24% from 10%.

According to RBI Governor Sanjay Malhotra, the combined effect of these regulatory relaxations and tax concessions is expected to improve foreign participation in government borrowing and support capital inflows into the debt market.

While the market participants welcome the announcements, they also raise the question whether tax incentives and regulatory relaxations alone persuade foreign investors to return. 

Positive Start, But Questions Remain

Industry experts have welcomed the announcements, calling it a meaningful attempt to improve India’s attractiveness among global investors at a time when capital flows are becoming increasingly selective. 

Naval Kagalwala, COO and Head of Products at Shriram Wealth said bond yields softened after the measures as investors assessed the potential impact of increased foreign participation in government borrowing. 

“The bond yields edged lower, with the RBI measures to boost foreign capital for GOI borrowing, along with tax benefits for FPIs announced,” he said. 

Other experts believe the reforms could strengthen India’s position in global fixed-income markets, especially as policymakers seek to attract more stable sources of foreign capital amid geopolitical uncertainty and volatile oil prices. 

The measures have also been welcomed for addressing long-standing concerns around access and taxation. "Removing the tax friction on government securities for FPIs is a good step," said Sachin Sawrikar, Founder and Managing Partner at Artha Bharat Investment Managers. 

While Sawrikar remains cautious about their impact on equity inflows, he acknowledged that the reforms improve the investment case for foreign debt investors.

On the other hand, brokerage firm SBI Capital Markets also sees broader benefits from the package. It said that the combined measures are expected to support the rupee, facilitate greater foreign participation in government securities and strengthen India's integration into global bond markets. 

It added that the reforms could ease the path for greater inclusion of Indian government securities in global bond indices, potentially unlocking additional overseas capital over time.

Yet even among those welcoming the announcements, there is recognition that these measures address only one aspect of the foreign investment equation. 

The Debt Advantage

The RBI’s latest measures suggest policymakers are trying to attract the “right kind” of foreign capital. At a time when equity inflows have been volatile and foreign direct investment (FDI) has moderated, debt flows are increasingly being viewed as an important source of external financing and macroeconomic stability.

The whole world is fixated on foreign portfolio flows into equities, according to the DSP Mutual Fund report, but FPI debt inflows are not insignificant. Since FY99, India has received $154.4 billion in FPI equity flows and $95.5 billion in FPI debt flows. Debt flows are 62% of cumulative equity flows and nearly 38% of combined equity plus debt FPI flows. 

Since India entered global bond indices, the character of debt flows has changed. The Debt-FAR route, which allows FPIs fully open access to specified government securities, has become the dominant channel. Since FY25, India has received around $19.3 billion of FPI debt inflows, of which $11.8 billion came through Debt-FAR. In March 2025, the single biggest month for FPI debt flows, India received $4.3 billion, of which $3.3 billion came through FAR. 

If the reported capital gains tax removal for FPIs in government securities goes through, FAR can become a quasi-open, tax-efficient window for global investors to buy Indian debt. It can also help the government in meeting its borrowing needs. 

“At a time when the capital account has been pressured by weak equity FPI flows and FDI outflows, debt flows can help bridge the current account deficit, reduce pressure on the rupee and give policymakers one more useful external sector stabilizer,” the report said. 

According to the report, FPIs prefer four things, which include positive real yield, stable or appreciating currency expectation, clean access and benign global risk appetite. India currently offers strong real yields, and the rupee valuation comfort has improved with broad REER below 90. 

“Access is the policy lever, and FAR already provides the base structure. Removal of capital gains tax can improve it further. It will provide better post tax returns to FPIs at a time when real yields are significantly higher than the past. Global risk appetite is not in India’s control, but when it turns favourable, the flow response can be large, as seen in 2014-15, 2017 and the recent bond-index inclusion phase,” it added. 

Eventually India will continue to run a current account deficit and will need to attract foreign capital through equity-based FDI. It believes that this is an ancillary solution which can help in an adverse global environment, and probably better than trying to only fix the current account using import duty on precious metals. 

Concerns That Tax Breaks Can’t Fix

While the latest measures may improve the foreign inflows via government securities, market participants caution that taxes have never been the only factor influencing foreign investment decisions. Broader macroeconomic and market concerns continue to outweigh tax considerations for many global investors, especially those allocating capital to equities. 

Sawrikar argues that these reforms primarily strengthen a segment that was already attracting investor interest. “Debt was the one segment that held steady. FPIs were net sellers in equities through much of the year,” he said. 

According to him, debt investors and equity investors operate with different mandates, risk appetites and return expectations, which makes it difficult for debt-focused incentives to alter broader foreign investment behaviour.

Apart from this, he pointed out that several long-standing concerns also remain unresolved. "Making gilts cheaper to own does not address why long-only equity investors have been cautious in India. The capital gains structure, the currency risk, the valuation premium over peers. That is where the silence is," Sawrikar added.

Currency volatility remains a key consideration. Even if investors earn attractive returns in local-currency assets, a weakening rupee can erode gains when converted back into dollars. This concern has become more relevant amid global uncertainty and rising geopolitical tensions, which have contributed to volatility in commodity prices and capital flows.

Valuations are another factor. Indian equities continue to trade at a premium to many emerging-market peers, which requires investors to justify paying higher prices based on future growth prospects. 

Together, these factors suggest that while tax exemptions and regulatory easing may improve India's appeal at the margin, they are unlikely to be the sole determinant of foreign investment flows. 

As Sawrikar said, “the real ask from foreign investors has always been on equities. That remains unanswered”. 

However, SBI Capital Markets said that these measures in unison are significant, and expected not only to stabilise the rupee, but to also ease inclusion of Indian G-secs in global indices and eventually provide a green light for equity investments to return.