Government Plans to Scrap Capital Gains Tax for FPIs: Why This Matters Now?

When a government moves through the ordinance route to change a tax law, it is not doing so casually. Ordinances bypass the usual legislative process. They are used when something needs to happen fast, when waiting for the next parliamentary session feels like a luxury the situation cannot afford.

On June 4, 2026, India signalled precisely that kind of urgency.

The Union Cabinet, chaired by Prime Minister Narendra Modi, approved an ordinance to amend the Income Tax Act and remove capital gains tax on FPI investments in government securities. A presidential assent and formal notification are the final steps before this change takes effect. But the direction is clear. India is scrapping a tax that has been sitting on foreign portfolio investors for years, and it is doing so right now, not in a budget session months away.

To understand why this matters, you need to understand what has been happening in Indian debt markets over the past several months.

The Tax That Was Always a Problem!

Right now, foreign portfolio investors buying Indian government securities pay a 12.5% long-term capital gains tax on bonds held for more than 12 months. They also pay a 20% withholding tax on interest income from those same bonds.

That combination is heavy. Very few major bond markets in the world charge overseas investors at this rate. Most countries that actively want foreign participation in their sovereign debt markets either exempt it entirely or keep the tax structure simple and low enough not to discourage inflows.

India’s rates were not competitive, and the industry had been saying so for years. Requests to reduce both the long-term capital gains tax and withholding taxes on government bond investments had been going into the government consistently. The 2023 decision to remove a concessional 5% withholding tax rate for FPIs had actually made things worse, not better.

The question was always when the government would act. The West Asia conflict and its fallout on Indian markets answered that question by making the cost of inaction too visible to ignore.

What Do the Numbers Look Like Right Now?

By June 2026, foreign portfolio investors had recorded net outflows of Rs 2.47 lakh crore from Indian markets. All of 2025 saw Rs 1.04 lakh crore in FPI exits. In other words, in roughly five months, foreign capital outflows from India had already crossed double what the entire previous year resulted.

The rupee felt every bit of that pressure. It hit a record low of 96.965 against the dollar on May 20, 2026, before recovering somewhat, helped by RBI intervention and some easing in oil prices following renewed US-Iran peace talks. But the underlying pressure on the currency had not gone away. The current account deficit was widening. The trade balance was stressed by high crude prices. And the departure of foreign capital from Indian debt markets was removing one of the stabilising forces that normally supports the rupee.

This is the backdrop against which the government decided to act on capital gains tax.

Why Government Securities Specifically?

India has been on the JP Morgan Government Bond Index-Emerging Markets since June 2024. That inclusion was a landmark moment, opening India’s sovereign debt market to a much larger pool of global institutional capital. Other index inclusions followed.

But index inclusion only works if global investors actually want to stay in Indian bonds. And staying in Indian bonds becomes a harder sell when you are paying 12.5% capital gains tax on the appreciation and 20% on the interest income, in a year when currency depreciation is already eating into your dollar-denominated returns.

The government securities market is different from equities. Investors in government bonds are not making a bet on a company’s growth story. They are looking for yield, stability, and a clear regulatory framework. Capital gains tax on these instruments makes Indian government securities meaningfully less attractive compared to sovereign bonds in competing markets. Removing that tax changes the arithmetic for global fixed income funds that are deciding how much India to hold in their portfolios.

The expected benefit is not subtle. Reduced taxes on FPI investments in government bonds mean better capital inflows into the debt market, which supports the rupee by bringing foreign dollars into the system, which reduces pressure on the RBI to intervene, which ultimately creates a more stable macroeconomic environment for everyone operating in Indian markets.

The Ordinance Route and What It Signals?

In 2019, the government lowered corporate tax rates via ordinance, making markets soar and positioning India as a more competitive investment spot. This context reminds us that using ordinances sends a specific message about time sensitivity, not routine policy tweaks.

Going through an ordinance rather than waiting for the next budget session signals that the government sees this as a time-sensitive measure, not a routine policy adjustment. The speed of execution matters here as much as the policy itself. Markets respond to decisive action.

Additional measures to encourage foreign capital inflows are also reportedly under discussion, suggesting this capital gains tax change is the first step rather than the complete response to the current situation.

What Does This Mean for Investors and the Broader Market?

For Indian investors tracking equity and debt markets, this development is significant for several reasons.

A reversal in FPI outflows from the government securities market would put downward pressure on bond yields. Lower yields mean higher bond prices, which benefits existing holders of Indian government debt. It also reduces the borrowing cost for the government itself, which has positive downstream effects on fiscal management.

A stronger rupee, helped by better foreign capital inflows, lessens the inflation from imported goods. This gives the Reserve Bank of India more space with monetary policy and cuts the currency-related drag. That’s why overseas investors have been selling Indian assets across the board; one of their main reasons for doing so, though, is now gone.

For equity market investors, a stabilising rupee and a more confident debt market environment typically translate into improved sentiment. FII re-entry into the debt market often precedes a broader improvement in foreign capital allocation toward India, including equities.

The bigger picture here is that the government is actively dismantling friction in India’s financial markets. The capital gains tax change on government securities is not happening in isolation. It comes alongside record trade deals, infrastructure investment, and a clear push to make India a more attractive destination for global capital in a period when that capital has several competing options.

What to Watch Next?

The presidential assent and formal notification are the immediate milestones. Once the notification is out, the change becomes operational, and FPIs can begin factoring the new tax structure into their bond investment decisions.

Watch for whether foreign portfolio investors begin reversing their positions in Indian government securities in the weeks that follow. A meaningful uptick in FPI buying of government bonds would confirm that the tax change is having the intended effect. Watch also for whether the rupee stabilises and strengthens as dollar inflows from bond purchases begin to come through.

Any additional measures that regulators announce alongside this change, and more are reportedly expected, will give a clearer picture of how comprehensive India’s effort to attract foreign capital is going to be through the rest of 2026.

Summing Up: A Smart Move at the Right Time

Removing capital gains tax on FPI investments in government securities is not just a tax policy change. It is a statement about what India’s government is willing to do to defend the stability of its markets and its currency during one of the most challenging external environments in recent years.

The ordinance route was the right call. The speed matters. And the direction is clear now.

At Bonanza Wealth, we track policy developments like this closely because they have direct implications for how portfolios should be positioned. Changes in the debt market tax structure affect bond yields, rupee dynamics, and ultimately equity market sentiment in ways that are interconnected and often underappreciated until the effects show up in returns. If you want to understand how this development fits into your own portfolio strategy, our team is here to help you think through it properly.

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