New Delhi: The Centre has announced a significant tax relief measure by exempting foreign investors from capital gains tax on government securities, in a move aimed at boosting overseas participation in India’s debt market and strengthening capital inflows.

The decision, notified through the Income-tax (Amendment) Ordinance, 2026, exempts foreign institutional investors (FIIs) and the Bank for International Settlements from paying capital gains tax and interest income tax on specified government bonds. The ordinance was promulgated by President Droupadi Murmu as Parliament is not currently in session.

The exemption will come into effect from April 1, 2026, and is expected to improve post-tax returns for foreign investors, making Indian government bonds more attractive globally.

What the tax exemption means

Under the previous tax regime, foreign investors were required to pay a 12.5% long-term capital gains tax on listed bonds held for more than one year. In addition, interest income earned from government securities was also taxable.

With the new exemption in place, eligible foreign investors will now be able to retain a larger portion of their earnings from investments in Indian government bonds. This effectively enhances the attractiveness of such instruments compared to other emerging market debt options.

The amendment to Schedule IV of the Income-tax Act, 2025, provides tax relief on both capital gains arising from the sale of specified securities and interest income generated from them, subject to certain conditions.

Push to attract stable foreign capital

The move comes at a time when India is facing pressure on its currency and capital flows. The rupee has weakened by more than 5% this year, largely due to rising crude oil prices and continued foreign outflows from domestic equity markets.

Policymakers have been seeking ways to attract more stable and long-term foreign capital, particularly into the debt segment, which is considered less volatile compared to equities.

By offering tax incentives, the government aims to deepen foreign participation in government securities and create a more resilient capital inflow framework.

Impact on India’s bond market

Analysts believe that while the tax exemption may not trigger an immediate surge in inflows, it is likely to have a positive impact over the medium term. Improved post-tax returns could encourage more global investors to allocate funds to Indian debt instruments.

The decision is also expected to broaden the investor base for government securities, reducing reliance on domestic institutions and enhancing market liquidity.

In recent years, India has taken several steps to integrate its bond market with global financial systems. This includes easing investment restrictions under the Fully Accessible Route (FAR), which allows foreign investors to invest in certain government securities without limits.

These reforms have helped India gain inclusion in major global bond indices, further increasing its visibility among international investors.

Supporting the rupee and economic stability

One of the key objectives behind the move is to support the rupee by attracting fresh dollar inflows. Increased foreign investment in government bonds can help offset capital outflows from equity markets and provide a more stable source of funding for the economy.

Foreign investors have remained net buyers of Indian government debt so far this year, even as they have withdrawn billions of dollars from equities. The tax exemption is expected to reinforce this trend by making debt investments more appealing.

Additionally, higher participation from global investors can help lower borrowing costs for the government over time by improving demand for its securities.

Broader policy direction

The exemption is part of a broader strategy to strengthen India’s financial markets and enhance their global competitiveness. By reducing tax barriers, the government is signalling its intent to make India a more attractive destination for international capital.

However, experts caution that global factors such as interest rate movements, geopolitical risks and commodity price volatility will continue to influence investment flows.

Conclusion

The Centre’s decision to exempt foreign investors from capital gains tax on government bonds marks a strategic step towards deepening India’s debt market and attracting stable foreign capital. While the immediate impact may be gradual, the policy is expected to improve investor sentiment, support the rupee and contribute to long-term financial stability.