India scraps bond taxes to woo foreign capital

India exempted foreign institutional investors from taxes on interest income and capital gains from government securities, using an ordinance to make its sovereign debt more attractive as policymakers try to draw stable overseas capital and ease pressure on the rupee.

The Income-tax (Amendment) Ordinance, 2026, promulgated by President Droupadi Murmu on 5 June, amends Schedule IV of the Income-tax Act, 2025.

The ordinance says it will be deemed to have come into force on 1 April 2026, making the relief effective from the start of the current tax year.

The move came on the same day the Reserve Bank of India (RBI) kept interest rates unchanged and announced a separate package to attract foreign capital, deepen debt-market participation and improve foreign-exchange liquidity.

Together, the measures signal that New Delhi and the RBI are trying to support the currency through inflows rather than a rate increase that could weigh on growth.

The tax relief is narrower than a blanket exemption for all overseas investors. The ordinance exempts “any interest on Government security” and “any capital gains arising from the sale, exchange or transfer of such Government security” earned by a Foreign Institutional Investor, subject to disclosure requirements.

A separate entry grants the same benefit to the Bank for International Settlements.

The ordinance defines “Foreign Institutional Investor” by reference to Section 210(6)(a) of the Income-tax Act, 2025, and defines “Government security” by reference to Section 2(f) of the Government Securities Act, 2006. The relief is tied to specified entities and specified securities.

The government issued the ordinance while Parliament was not in session, saying circumstances required immediate action.

As with all ordinances, it has the force of law immediately but will need to be placed before Parliament for continuation through legislation.

The ordinance itself cites Article 123 of the Constitution as the basis for the move.

The Finance Ministry said the exemption is aimed at facilitating investment in government securities and streamlining the tax framework for eligible foreign investors.

Before the change, FIIs faced capital-gains tax on government bond holdings and withholding tax on interest income from such securities.

The rupee has weakened this year under pressure from higher oil prices, foreign outflows and geopolitical stress. The domestic currency strengthened about 0.6% to 95.24 against the dollar after the RBI’s measures to attract dollar inflows.

The move to scrap tax is a currency-management tool as by improving post-tax returns on government securities, the government is trying to make Indian sovereign debt more competitive for global funds at a time when capital flows into emerging markets have become more volatile.

The ordinance also supports the RBI’s decision to widen access to government securities.

The central bank announced that all new 15-year, 30-year and 40-year government securities would be included under the Fully Accessible Route, which allows non-resident investors to buy specified government bonds without the usual investment caps.

The RBI also removed investment concentration limits under the route and eased some equity-investment norms for non-residents.

Investment limits for non-resident Indians and overseas citizens of India in listed equity instruments without SEBI registration have been increased, and the facility is being extended to all individual persons resident outside India.

The central bank’s other measures focus on dollar funding. It announced concessional foreign-exchange swap facilities, support for dealer banks raising Foreign Currency Non-Resident Bank deposits, and a restoration of export-realization timelines to nine months from the earlier temporary extension of 15 months.

These steps are intended to improve foreign-exchange liquidity and accelerate the return of export proceeds into the country.

While the government has acted through tax law, the RBI has acted through market access, forex swaps, deposit incentives and export-realization rules.

The Monetary Policy Committee, meanwhile, kept the repo rate unchanged at 5.25%, choosing not to use rates as the first line of defense for the rupee.

Governor Sanjay Malhotra said the RBI does not target any specific exchange-rate level or band and would act to curb excessive volatility and disorderly movements.

The policy package reflects a difficult trade-off. A weaker rupee can feed imported inflation, especially through crude oil and other dollar-priced commodities. But raising rates to defend the currency would risk hurting domestic demand at a time when the RBI has already lowered its growth forecast and raised its inflation projection.

By cutting the tax burden on eligible foreign investors in government securities, the government is trying to widen the pool of long-term debt buyers. By expanding bond access and lowering friction in foreign-currency funding, the RBI is trying to bring dollars into the system without choking credit conditions, analysts said.

The measures may improve sentiment, but they are not a guarantee of sustained inflows. Foreign investors will still weigh India’s yields against currency risk, oil prices, global rates and geopolitical uncertainty. The disclosure conditions in the ordinance also mean the exemption is not automatic for every foreign participant in Indian debt markets, the analysts added.