In a major policy shift aimed at aggressively courting global capital, the Union Cabinet has approved a plan to completely scrap the capital gains tax on investments in government securities (G-Secs) made by Foreign Portfolio Investors (FPIs/FIIs).

The decision, finalized during a Cabinet meeting chaired by Prime Minister Narendra Modi on Wednesday, will be fast-tracked through an ordinance amending the Income Tax Act. By utilizing the ordinance route, New Delhi is bypassing the wait for a formal parliamentary session to immediately boost the country’s sovereign debt appeal. A formal notification is expected to be made public by this week as soon as it receives presidential assent.

1. Dismantling the Existing Tax Barriers

The sweeping tax holiday addresses a long-standing grievance cited by global funds, who have argued that the tax overhead drastically eroded the yield attractiveness of Indian sovereign paper.

• The Capital Gains Rollback: Under the current fiscal framework, foreign investors are subject to a 12.5% Long-Term Capital Gains (LTCG) tax on listed bonds held for over 12 months. This friction point is now being completely erased for government securities.
• Withholding Tax Changes: Government sources indicate that policymakers are also evaluating the rollback of the 20% withholding tax currently levied on interest earned from these sovereign bonds. The concession follows the government’s 2023 decision that ended the historical 5% concessional withholding rate, a tightening move that market participants have continuously lobbied to reverse.

2. Macro Strategy: Countering Geopolitical Volatility

The timing of the ordinance is heavily dictated by shifting global investment trends and mounting macroeconomic headwinds:

The War Shock & Currency Defenses

The persistent conflict in West Asia has rattled global financial supply lines and fueled broader emerging-market risk aversion. This friction has put heavy pressure on the local currency. While the Reserve Bank of India (RBI) has aggressively stepped up support to steady the currency, the Indian Rupee fell to an all-time low of 96.965 against the US Dollar on May 20 before showing signs of stabilization. Deepening foreign capital participation in G-Secs is viewed as a vital cushion to support the Rupee long-term.

Deepening the Divergence in Flows

The tax removal looks to accelerate a stark divergence between equity and fixed-income allocations by global desks this year:

With net exits by FPIs from broader Indian assets crossing ₹2.47 lakh crore so far this calendar year—more than doubling the entire outflow seen in 2025—the bond market has remained a rare bright spot, pulling in a positive net layer of $1.4 billion.

3. Lowering Government Borrowing Costs

Beyond defending currency positions, deep foreign fund inflows into the domestic debt ecosystem serve a direct fiscal utility: managing India’s sovereign borrowing costs.

When global asset managers and sovereign funds aggressively bid for Indian treasury blocks, it drives bond yields down. This shift allows the Central Government to fund its large infrastructure and public development projects at far more favorable interest rates.

Financial regulators are reportedly planning a sequence of complementary measures to ensure maximum secondary market liquidity once the tax exemption goes fully live, framing it as a structural upgrade to permanently anchor India within top-tier global bond indices.