MSCI India Index has underperformed the MSCI Emerging Markets Index over the past year by the highest margin in over three decades. Foreign Institutional Investors (FIIs) pulled Rs 3,00,000 crore (about $31 billion) out of Indian equities in 2025 and Rs 3,40,000 crore (about $35 billion) in the first six months of 2026 alone. The rupee has been weak. India’s capital account is struggling, and foreign ownership of Indian stocks at a 15-year low. The window to act is narrowing as global dollar liquidity stays expensive.
Competition for capital is set to intensify further as the US Federal Reserve is widely anticipated to follow the European Central Bank in hiking rates later this year. Thankfully, however, now that India’s valuations have cooled from their 2024 extremes, our discussions suggest that meaningful pools of global capital remain constructive on India’s long-term prospects.
The sticking point for foreign investors is India’s capital gains tax (CGT) regime, long been viewed by them as outdated and anomalous. The said CGT regime is increasingly viewed as an avoidable impediment to fresh allocations by large global investors to India, particularly given that most competing markets do not impose comparable capital gains taxes on FIIs.
With foreign ownership of Indian stocks at a 15-year low, the question is how Indian policymakers can restore India’s standing as a preferred destination for global allocators. Given the prevailing macroeconomic constraints in India, reducing equity CGT rates for FIIs appears to us to be one of the few policy levers available to the finance ministry that can improve India’s competitiveness for global capital without materially compromising fiscal consolidation. We explain below why this is so.
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India & foreign investors
The first and most obvious reason is that India’s treatment of foreign portfolio investors is increasingly out of step with global practice. The US, the UK, Germany, Japan and every major emerging market peer—Korea, Brazil, China, Taiwan—exempt foreign portfolio investors from CGT on listed equities.
India’s 12.5 percent long term capital gains (LTCG) tax and 20 percent short term capital gains tax (STCG) rates have no parallel among the markets we compete with for capital. While India was the emerging market destination of choice in the previous decade, equity investors have real alternatives now—Korea’s Value-Up programme, Taiwan’s semiconductor ecosystem, Japan re-rating for the first time in a generation, and Brazil trading at a fraction of our multiples at a time when commodities are doing well.
The arithmetic of a tax exemption targeted at FIIs is straightforward. CGT collections on listed equities is approximately Rs 100,000 crore a year. With foreign investors owning only around 15 percent of India’s listed market capitalisation, a simple ownership-based approximation suggests a revenue impact of around Rs 15,000 crore (around $1.5 billion). The potential macroeconomic benefits to India, however, accrue across a much larger base—India’s Rs 200,00,000 crore sovereign debt market, the exchange rate, and domestic financing conditions.
By strengthening the capital account and reducing the risk premium embedded in Indian financial assets, a tax cut could lower sovereign borrowing costs, support the rupee and ease imported inflation. Even a 50-basis-point reduction in sovereign yields would save the exchequer roughly Rs 8,000 crore in the first year on new issuance alone, with the benefits compounding over time as debt is refinanced at lower rates.
A common objection in India is that exempting foreign investors while taxing domestic investors creates an uneven playing field. But foreign capital is uniquely mobile and competes across jurisdictions in a way that domestic savings do not. Tax policy toward globally mobile capital should therefore be judged by its contribution to national welfare rather than identical treatment across investor classes.
A retail investor sitting in India simply does not have the range of global choices open to him that a FII sitting in London or New York does and this leads us to our next point in favour of giving CGT relief to FIIs.
Capital gains tax & FIIs
Foreign investors already pay an implicit tax that domestic investors do not: The Indian rupee has depreciated by approximately 3.5 percent per annum against the US dollar over the last decade. Investment of $100 in Indian assets a decade ago at Rs 65 to the dollar is worth roughly $68 today on a pure-currency basis, before any equity return is even measured—a cumulative erosion of nearly 32 percent just from FX.
Layer a 12.5 percent capital gains tax on top of a 3.5 percent annual currency drag and the after-tax, after-FX return that an FII requires to justify Indian exposure becomes materially higher than the pre-tax return facing a domestic investor for the same asset. The domestic investor has no such currency drag. Symmetric tax treatment across investor classes therefore delivers asymmetric real-return outcomes, and is not the neutral policy stance it appears to be.
Arthur Laffer’s original insight was that beyond a certain rate, raising taxes can reduce revenues because the tax base shrinks in response. For capital gains, where the act of investing is voluntary, the elasticity is unusually high for FIIs. India’s hikes over the years from zero to 12.5 percent on LTCG saw the Laffer response migrate entirely to FIIs, who measure dollar-denominated post-tax returns against a global opportunity set and now find better risk-adjusted returns in markets charging zero taxes on capital gains.
Alongside premium valuations, slowing earnings growth and the absence of a large domestic Artificial Intelligence (AI) beneficiary, the CGT regime has become an important headwind to foreign allocations.
Conversely, the same response was largely absent among domestic investors, whose savings remain relatively captive. A 12.5 percent equity tax remains considerably more attractive than 39 percent on a fixed deposit or debt instrument for a retail investor. Indian retail investors had no alternative; they absorbed the higher tax drag without a drop in market participation. The behavioural response to higher capital gains taxation was therefore concentrated among foreign investors.
The debt experiment has already proved the mechanism. Through the Income-tax Amendment Ordinance of early June 2026, the Government of India wiped out remaining withholding and CGT friction on Fully Accessible Route sovereign bonds for foreign investors. The response was instantaneous: over Rs 35,000 crore of fresh FII debt inflows in subsequent weeks, and a 15-basis point fall in the 10-year yield.
The replication case on equity is stronger due to the inherent nature of sovereign risk. While foreign debt creates rigid, contractual repayment obligations that can severely strain a nation’s balance of payments during an economic downturn, equity capital carries no such sovereign liability.
Equity is permanent risk capital that shares in the economic downside, making a tax-induced shift toward foreign equity a safer way to fund our capital account deficit. Fiscal-discipline objections to a tax cut rooted in the budget’s 4.3 percent deficit target underestimate how the broader macro responds. A stronger rupee also reduces imported inflation and gives the Reserve Bank of India room to ease monetary policy.
There is also a longer-term reason why attracting foreign capital matters. The information technology services sector that has supported India’s balance of payments for two decades faces, for the first time, a credible challenge from AI.
The optimistic case that India eventually emerges as a major manufacturing exporter is real, but will take time to materialise. In the interim, the capital account remains India’s most immediate lever for funding investment, supporting the rupee and financing infrastructure. The current tax framework unnecessarily discourages precisely the kind of long-term foreign capital India needs.
Cutting the equity tax now is one of the rare policy measures whose potential benefits appear disproportionate to its fiscal cost. The case stands on the static arithmetic alone and grows stronger with every second-order consequence and with every passing week.
Mohandas Pai is the Chairman of Aarin Capital. Saurabh Mukherjea and Tej Shah work for Marcellus Investment Managers.
(Edited by Nardeep Singh Dahiya)
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