At present, FIIs pay 12.5% tax on long-term capital gains, 30% on short-term capital gains, and around 20% withholding tax on interest income.
The decision, taken after at least two months of internal discussions, is expected to bring tens of billions of dollars in foreign fund into government debt over the coming years, and bridge to some extent the looming balance of payments (BoP) deficit that economists estimate could even touch $60 billion in 2026-27.
In an ordinance promulgated to amend the Income Tax Act, 2025, after President Droupadi Murmu gave her assent, the government said the changes will come into effect from April 1, 2026.
FII investment in government bonds stands at Rs 3.75 lakh crore, or just 3.34% of the available amount of Rs 112.42 lakh crore, under the so-called General Route and Fully Accessible Route (FAR).
These are the two ways in which foreign investors invest in Indian government securities.
According to Axis Bank economists, no tax on FII investment in government debt could lead to $45-50 billion inflows over two years.
While the rupee has gained some ground since nearly breaching the 97-per-dollar mark last month, it is down 5% since the war began on February 27 and has slumped 10.3% in the last one year.
After closing at 95.79 per dollar on Thursday, it had strengthened to 95.45 at 1PM Friday.
Meanwhile, yields on government bonds declined following the promulgation of the ordinance.
The tax exemption on “any interest on Government security, and any capital gains arising from the sale, exchange or transfer of such Government security” applies to FIIs as well as the Bank for International Settlements.
The BIS is an organisation of central banks from around the world.
