The Government of India has introduced a significant reform in its bond market by eliminating tax liabilities on investments made by foreign investors in government securities. Through the Income-tax Amendment Ordinance, 2026, promulgated on June 5, 2026, the Centre has removed capital gains tax as well as withholding tax on interest income for eligible foreign investors.
This change, which takes effect retrospectively from April 1, 2026, aims to enhance the attractiveness of Indian government bonds and draw stable overseas capital into the economy.
Prior to this reform, foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) faced a considerable tax burden on their bond investments. Interest income earned from government securities was subject to a 20 percent withholding tax. In addition, long-term capital gains arising from bonds held for more than one year were taxed at 12.5 percent, while short-term capital gains attracted a higher tax rate of 20 percent.
These tax provisions reduced the competitiveness of Indian bonds relative to other global fixed-income instruments, thereby limiting foreign participation in the domestic debt market.
The newly introduced ordinance amends Schedule IV of the Income-tax Act, 2025, and provides a complete tax exemption on both interest income and capital gains for specified government securities held by eligible foreign investors.
This includes FIIs, FPIs, other overseas investors, and even multilateral institutions such as the Bank for International Settlements. However, these benefits are contingent upon compliance with prescribed disclosure and reporting requirements, ensuring transparency while facilitating ease of investment.
This policy shift comes at a time when India is facing external economic pressures. The Indian rupee has depreciated by approximately 7 percent in 2026 and has weakened further since the escalation of geopolitical tensions in West Asia earlier in the year.
Simultaneously, foreign investors have withdrawn nearly 28 billion dollars from Indian equity markets, highlighting the volatility of equity flows. In contrast, net foreign investment in Indian bonds has remained relatively modest, at around 1.4 billion dollars, underscoring the need to incentivize more stable capital inflows.
The government’s objective is to redirect foreign capital from volatile equity markets toward more stable sovereign debt instruments. By making government bonds entirely tax-free for foreign investors, India aims to attract long-term investments that contribute to financial stability and support the country’s balance of payments. This is particularly important given India’s substantial funding requirement of approximately 4.76 lakh crore rupees.
Complementing this fiscal measure, the Reserve Bank of India has implemented regulatory changes to facilitate foreign participation in the bond market. Certain long-tenor government securities have been designated under the Fully Accessible Route (FAR), allowing foreign investors to invest without any quantitative restrictions.
The central bank has also expanded the range of eligible securities and removed concentration limits on short-term investments, further easing market access. Additionally, investment limits for non-resident Indians and overseas citizens of India in equity markets have been increased, broadening the scope for foreign capital inflows.
The broader macroeconomic impact of this reform is expected to be positive. Increased foreign investment in government bonds will lead to higher inflows of foreign currency, which can help stabilize the rupee.
A stronger currency, in turn, reduces the cost of essential imports such as crude oil, thereby easing inflationary pressures. By encouraging sustained capital inflows into debt markets, the government is also working toward building a more resilient financial system capable of withstanding global uncertainties.
Overall, this reform represents one of the most decisive steps taken by India to deepen its bond market and integrate it more closely with global financial systems. By removing tax barriers, the government has positioned Indian government securities as a highly competitive investment option for foreign investors, signaling its commitment to attracting stable, long-term capital during a period of economic uncertainty.
