India FII G-sec tax break may draw $40bn in 2026 plan

What changed and why markets are watching it

India has rolled out a broad set of measures to attract foreign capital, combining a retrospective tax exemption for foreign investors in government securities with Reserve Bank of India (RBI) steps to widen bond-market access and encourage foreign currency inflows. SBI Research estimates the combined impact of the Centre’s tax relief and RBI reforms could potentially attract at least $10 billion, which it equates to about ₹3.81 lakh crore at an exchange rate of ₹95.24 per dollar. The stated policy intent is to bring in more durable, long-term overseas capital rather than short-term flows.

The government’s ordinance focuses on a long-standing friction for global bond funds: taxes on interest income and capital gains from Indian government bonds. In parallel, the RBI has expanded the Fully Accessible Route (FAR) for certain longer-dated government securities and introduced facilities aimed at boosting external commercial borrowings (ECBs) and foreign currency deposit inflows.

The Income-tax (Amendment) Ordinance, 2026: the core tax shift

The Centre has issued the Income-tax (Amendment) Ordinance, 2026, exempting interest income and capital gains earned by eligible foreign investors on investments in government securities from income tax. The move takes effect retrospectively from April 1, 2026. It applies to Foreign Institutional Investors (FIIs) or foreign portfolio investors (FPIs), as referenced in the related provisions, and also extends to the Bank for International Settlements (BIS).

The ordinance removes two major tax costs that foreign investors faced on these investments. First, it eliminates the 12.5% long-term capital gains tax (LTCG) on government bonds held for more than 12 months. Second, it removes the 20% withholding tax on interest income earned from government securities. The Finance Ministry has said the objective is to attract long-term foreign capital from categories such as pension funds, sovereign wealth funds, and insurance companies, while making Indian markets more competitive.

What investors potentially save: SBI Research estimates

SBI Research quantified the potential benefit to foreign investors from the tax exemption. It estimates foreign investors could gain ₹4,000 to ₹5,000 crore from the exemption on interest income and ₹500 to ₹1,000 crore from the capital gains tax exemption. Together, these changes improve post-tax returns on Indian government securities relative to many competing global debt markets.

Market participants discussing the move have also argued that removing the tax layer can mechanically lift net returns for foreign investors in Indian bonds. Vaibhav Sanghavi, CEO at ASK Hedge Solutions, said bond-market returns for FIIs would rise as the tax goes away, which could bring in more bond inflows and ease pressure on the rupee.

RBI expands the Fully Accessible Route for longer tenors

Alongside the tax ordinance, the RBI has announced measures to increase foreign participation in India’s debt market. The central bank has brought new 15-year, 30-year, and 40-year government securities under the Fully Accessible Route (FAR). Under FAR, foreign investors can access these bonds without restrictions that otherwise apply.

In addition, the RBI said limits related to short-term investment, concentration, and individual securities on FPI investment under the General Route are being removed. SBI Research believes that widening access to longer-dated paper can increase demand for long-term government securities, improve liquidity, and lower government borrowing costs.

Concessional forex swaps for PSU ECBs

The RBI has also introduced concessional foreign exchange swap facilities aimed at encouraging External Commercial Borrowings (ECBs) by public sector enterprises. The stated intent is to help government-owned companies access cheaper overseas funding, while supporting foreign currency inflows.

Separately, reporting on the RBI’s measures noted that the concessional foreign exchange swap facility for ECBs by public sector enterprises would be available until June 30, 2026. Analysts cited in the discussion also linked the swap window to near-term stability in market rates and the foreign exchange market.

FCNR(B) deposits: hedging support and a 2013 comparison

Another major element is the push to attract foreign currency inflows via Foreign Currency Non-Resident (Bank) deposits, or FCNR(B). With the RBI bearing hedging costs and offering temporary regulatory relaxations, banks may be able to offer more attractive returns to non-resident Indians (NRIs).

SBI Research said FCNR(B) deposits could potentially attract inflows exceeding the $14 billion mobilised during the 2013 FCNR(B) drive. In the RBI’s new window, authorised dealer banks will have access to a temporary facility where the RBI will cover the complete hedging cost for new 1-year to 5-year FCNR(B) deposits mobilised until September 30, 2026.

NRI, OCI and PROI equity participation: limits are raised

Beyond bonds and forex measures, the RBI has also raised investment limits for NRIs and Overseas Citizens of India (OCIs) in listed equity instruments without requiring registration with the securities regulator. The facility is also proposed to be extended to all individual Persons Resident Outside India (PROIs), bringing them on par with NRIs and OCIs.

Market commentary framed this as a step that could broaden participation and improve market depth and liquidity. The same set of announcements came alongside the RBI keeping the repo rate unchanged at 5.25%.

Why this matters now: rupee pressure and foreign flows

One of the motivations cited for the package is currency stability. A report in the provided material stated the rupee has depreciated over 6% this year due to soaring oil prices and foreign portfolio outflows from equities. In that context, reducing tax friction for bond investors and widening market access is positioned as a way to encourage foreign engagement in sovereign debt and support the rupee.

Anindya Banerjee, head of commodity and currency research at Kotak Securities, described the mix of FAR expansion, removal of FPI concentration limits, FCNR(B) hedging support, the PSU ECB swap window, and restoration of the export realisation period to nine months as the most comprehensive dollar-mobilisation effort since 2013. He also said the removal of taxes on foreign investment in government securities acts as a force multiplier by addressing a key friction flagged by global bond funds and index providers.

Key measures at a glance

Market impact: bonds, liquidity and government borrowing

The direct channel is post-tax returns. By removing the LTCG and withholding tax costs, the ordinance increases net yields for eligible foreign investors in Indian government bonds. If this results in higher foreign participation, market depth and secondary-market liquidity in longer tenor G-secs could improve, especially with the expanded FAR universe.

SBI Research linked higher participation to potentially lower government borrowing costs, as deeper demand for long-term bonds can support pricing. The combination of bond inflows, ECB-related forex inflows, and FCNR(B) mobilisation is also framed as a way to strengthen the external sector and improve overall liquidity.

Analysis: what makes this package different

A key feature is the retrospective start date of April 1, 2026, which covers the full financial-year window from the beginning. That structure is intended to reduce uncertainty for foreign investors considering allocation decisions for Indian sovereign debt.

The package also layers multiple levers. The government addressed taxation, while the RBI targeted access (FAR expansion and route-limit relaxations) and foreign-currency supply (ECB swap window and FCNR(B) hedging support). SBI Research’s $10 billion inflow estimate sits alongside a second benchmark: the 2013 FCNR(B) drive that mobilised $14 billion, which is used in the material as a reference point for the scale of potential foreign currency deposit inflows.

Conclusion

India’s retrospective tax exemption on interest income and capital gains for eligible foreign investors in government securities, paired with RBI measures on FAR, ECB swaps, and FCNR(B) deposits, represents a coordinated attempt to attract long-term foreign capital. SBI Research estimates these steps could potentially bring at least $10 billion, or about ₹3.81 lakh crore, into the country. Key near-term milestones embedded in the measures include the ECB swap facility window until June 30, 2026 and the FCNR(B) mobilisation period until September 30, 2026.