India Plans to Scrap 12.5% Capital Gains Tax on FPI G-Sec Investments

New Delhi, June 4 — India’s Cabinet, chaired by Prime Minister Narendra Modi on Wednesday, approved an ordinance to amend the Income Tax Act and eliminate capital gains tax on government securities held by foreign portfolio investors (FPIs), according to people familiar with the matter.

 

A formal notification is expected shortly.

 

The decision comes as total FPI equity outflows in 2026 hit ₹2.25 lakh crore by end-May, already surpassing the entire ₹1.66 lakh crore pulled out in 2025, with the government under pressure to arrest a sustained bleed of overseas capital.

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What Exactly Is Being Scrapped

Currently, FPIs pay a 12.5% long-term capital gains (LTCG) tax on gains from Indian government securities, a rate that was raised from 10% just last year under the Union Budget 2025, a hike that experts at the time warned would dent fixed-income inflows.

 

The proposed ordinance would eliminate this levy specifically on G-secs, making Indian sovereign bonds significantly more attractive to yield-sensitive overseas investors such as pension funds, sovereign wealth funds, and insurance companies.

 

Key details of what changes:

The targeted nature of the relief is significant; it covers G-secs only, not corporate bonds or equities. That is a deliberate choice: sovereign bond inflows directly support rupee stability and keep government borrowing costs in check without opening a broader tax concession on all FPI asset classes.

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Why the Government Chose the Ordinance Route

 

Ordinances under Article 123 of the Constitution require the President’s assent and are used only when Parliament is not in session and urgent action is warranted. The government bypassing the normal legislative route signals just how urgently New Delhi views the capital flight problem.

 

Hostilities in West Asia broke out on February 28, 2026, triggering a crude oil spike to the $95–108 per barrel range; a rupee depreciation of nearly 6% in 2026 alone, from the mid-80s to 95.5 against the dollar; and a record monthly FPI outflow of ₹1.17 lakh crore in March 2026.

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The Full Scale of the FPI Damage — By the Numbers

 

The outflow data tells a stark story:

March was the defining month, a single-month outflow that exceeded the previous record of ₹94,017 crore set in October 2024.

 

FPIs were net sellers in every month of 2026 except February.

 

By the same period, aggregate foreign ownership in Indian listed stocks fell to 14.7%, a 14-year low, while domestic institutional holdings crossed 18.9%.

 

The rupee factor cannot be separated from the flow picture.

 

As Sachin Jasuja of Centricity WealthTech put it, with India importing over 80% of its crude requirements, the sharp rise in Brent crude from the $70 per barrel range to $95–105 amid Strait of Hormuz disruptions directly widened the import bill and the current account deficit, and a weaker rupee directly hits dollar-denominated returns for foreign investors.

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The G-Sec Specific Story — A ₹3.13 Lakh Crore Market at Stake

 

This is the angle most coverage misses. The FPI equity outflow grabs headlines, but the sovereign bond market has its own crisis running in parallel.

 

FPI investment in FAR government securities declined from ₹3,31,007 crore on February 27, 2026, just before the West Asia conflict, to ₹3,13,318 crore by April 1, a drawdown of ₹17,689 crore in roughly five weeks. That is a ₹3.13 lakh crore market being actively unwound.

 

The trend in FAR G-sec flows across recent years:

The 12.5% LTCG levy on G-sec gains sits at the top of the list of friction costs that make this market less attractive relative to peers. Removing it eliminates one of the clearest disincentives for overseas fixed-income capital to stay in Indian sovereign debt.

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Analyst Take: Tactical Friction Removal, Not a Structural Fix

 

Not everyone sees this as a game-changer. FPI inflows into debt instruments are highly sensitive to tax rates, changes in rates for debt instruments meaningfully impact after-tax returns, which is a crucial factor in investment decisions, as FPI inflows are typically characterised as hot money, noted Vivek Iyer of Grant Thornton Bharat.

 

Removing the 12.5% LTCG on G-secs improves the post-tax yield calculation for overseas bond investors, but it doesn’t address the rupee risk, crude price volatility, or the yield spread compression that drove much of the FY26 outflow.

 

The yield spread context matters: when the spread between India’s 10-year benchmark bond and the US 10-year bond narrowed toward 190 basis points in June 2025, outflows accelerated; when it widened back to 251 basis points, FPIs returned as net buyers.

 

Tax relief works best when yield spreads are already supportive. If crude stays elevated and the rupee remains under pressure, even a zero LTCG rate may not be enough to pull large fixed-income allocators back in size.

 

Oddly, the government is effectively unwinding a hike it introduced just over a year ago, Budget 2025 raised G-sec LTCG for FPIs from 10% to 12.5%. Now it wants to go to zero.

 

That reversal, driven by emergency geopolitical circumstances, will raise questions about policy stability that overseas investors pay close attention to.

 

Read Next: Stocks in Focus, June 4, 2026: 5 Stocks That Could Move Today — From SEBI Order to Flex Fuel Launch

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Frequently Asked Questions

 

Q: Which government securities are covered, all G-secs or only FAR bonds?

 

The ordinance targets government securities broadly, but the exact instruments covered will only be confirmed in the formal Income Tax Act notification. Most relevant for overseas investors is the ₹3.13 lakh crore FAR G-sec segment, which is the fully accessible route open to FPIs without investment caps.

 

Q: How does India’s G-sec tax compare with rival markets after this change?

 

A zero capital gains rate on sovereign bonds would put India broadly in line with sovereign debt tax treatment in markets like Japan and South Korea, which offer favourable or zero CGT on government bond gains for foreign investors, a meaningful competitive signal for index-linked bond funds.

 

Q: When will FPIs actually feel the impact, is a formal notification enough?

 

No. The ordinance grants legal authority. A separate gazette notification under the Income Tax Act sets the effective date and exact scope. Until that notification is published, the 12.5% LTCG rate remains applicable. Large institutional investors, pension funds, and sovereign wealth funds typically wait for gazette-level clarity before adjusting allocations.

 

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The next data point to watch: NSDL’s weekly FPI flow update and CCIL’s FAR G-sec utilisation figures in the days following the formal notification, these will be the first hard evidence of whether overseas bond investors are ready to re-engage with Indian sovereign debt.