BT Explainer: Centre exempts foreign investors from taxes on G-Sec investments via Ordinance -- What it means for India’s bond market

In a significant move aimed at attracting overseas capital, the Centre has issued an Ordinance exempting foreign portfolio investors (FPIs) from capital gains tax on investments in specified Indian government securities. The decision, approved by the Union Cabinet and announced alongside the Reserve Bank of India’s June monetary policy, is expected to make India's sovereign debt market more competitive globally and encourage greater foreign participation.

The measure comes at a time when India is seeking stable foreign capital inflows amid elevated crude oil prices, geopolitical uncertainties, and a challenging global investment environment that has seen foreign investors pull money out of Indian equities.

What has changed?

Until now, foreign investors were subject to a 12.5% long-term capital gains tax on listed securities, including government bonds, if held for more than one year. Interest income earned on government securities also attracted a 20% withholding tax.

The newly issued Ordinance removes the capital gains tax burden on eligible government securities held by foreign investors. Market participants are now awaiting the detailed notification to understand the scope of the exemption, including whether any relief will also be provided on the withholding tax applicable to interest income.

Simultaneously, RBI Governor Sanjay Malhotra announced measures to deepen foreign participation in India's bond market. The central bank expanded the Fully Accessible Route (FAR) to include new issuances of 15-year, 30-year and 40-year government bonds, making a larger pool of sovereign debt available to overseas investors without investment limits.

The RBI also enhanced investment limits for Non-Resident Indians (NRIs) and Overseas Citizens of India (OCIs) investing in Indian equity markets without SEBI registration and proposed extending similar benefits to all individual Persons Resident Outside India (PROIs).

Why the move matters

Experts say taxation has long been one of the key obstacles preventing larger foreign participation in India's government bond market.

Vipin Upadhyay, Partner at King Stubb & Kasiva, said the decision addresses a longstanding concern among global investors.

"Exempting FPI holdings in government securities from capital gains tax goes straight to foreign investors' oldest grievance, that India is one of the few markets that taxes non-residents on sovereign debt flows," he said.

According to Upadhyay, removing the tax increases post-tax returns for overseas investors and makes Indian government securities more competitive relative to other emerging market debt markets.

However, he noted that finer details remain crucial.

"The decisive detail will be whether the relief extends to the 20% withholding tax on interest, and how eligible instruments and investors are defined. Until the notification follows Presidential assent, this is directional, not yet law," he added.

Potential impact on foreign inflows

India has been steadily trying to broaden the investor base in its government securities market, which continues to be dominated by domestic banks.

Rakesh Goel, Lead Consultant – Indirect Tax at AQUILAW, said the exemption is part of a broader effort to deepen India's debt markets.

"For global investors, tax considerations often play a critical role in determining the attractiveness of a particular market. Capital gains tax can significantly reduce post-tax returns, especially for investors managing large fixed-income portfolios across multiple jurisdictions," Goel said.

By eliminating this tax burden, India could improve the attractiveness of its government bonds compared to other emerging market peers.

Greater foreign participation could also improve liquidity in the secondary bond market, narrow bid-ask spreads, and improve price discovery. A more diversified investor base would reduce dependence on domestic banks and create a more resilient borrowing ecosystem for the government.

Additionally, sustained debt inflows could provide support to the rupee by generating a steady source of foreign exchange inflows.

Boost for global bond index inclusion

The move gains additional significance following India's inclusion in major global bond indices, including JPMorgan's Government Bond Index-Emerging Markets (GBI-EM).

India's FAR securities have already attracted passive inflows from international funds tracking these indices. However, taxation has remained a recurring concern for foreign investors and fund managers.

Removing capital gains tax addresses one of the key friction points and could encourage not only passive index-related investments but also larger allocations from active global asset managers, sovereign wealth funds, pension funds and insurance companies.

While the government will have to weigh the fiscal cost of the tax exemption, market participants believe the long-term benefits of deeper capital markets, improved liquidity and stronger foreign participation could outweigh the immediate revenue sacrifice. The Ordinance signals India's continued push to integrate more closely with global financial markets and strengthen its position as a major destination for international fixed-income capital.