ATTRACTING FOREIGN CAPITAL NEEDS MORE THAN TAX CUTS

Why In News?

Experts argue that tax cuts alone will not reverse heavy foreign portfolio investor (FPI) outflows. 

What is FPI?

Foreign Portfolio Investment (FPI) refers to non-resident investments in financial assets like equities, bonds, and mutual funds without granting operational or management control.

Key Characteristics of FPI

• Passive Ownership: Investors seek financial returns (dividends, interest, or capital appreciation) rather than running or managing the company.

• The 10% Threshold: In India and many other jurisdictions, an FPI generally holds less than a 10% equity stake in a listed company. Acquiring 10% or more reclassifies the investment as Foreign Direct Investment (FDI).

• High Liquidity: FPI assets are bought and sold easily on public stock and debt exchanges, making them more mobile and shorter-term than direct business investments.

• Regulatory Oversight: In India, FPIs are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Foreign Portfolio Investors) Regulations, alongside guidelines from the Reserve Bank of India (RBI).  

What Is The Scale Of FPI Outflows?

• Long-Term Exodus: Since 2024–25, FPIs have withdrawn about $51 billion from Indian equity markets.  

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• Record 2026 Selling: FPI equity outflows in 2026 have crossed about ₹3 lakh crore, the highest ever.  

• FY 2025–26: FPI flows recorded a net outflow of about $16.7 billion, while net FDI rose to $7.7 billion.  

• Weaker Rupee: The rupee has depreciated about 5.6% against the US dollar in 2026, hitting a record low of about ₹97 per dollar in May 2026.  

Finance Minister's View

• Tax Not The Only Factor: Sitharaman noted that India's tax structure was similar in 2023–24, when foreign inflows were strong. She said that challenges have grown since then.  

• Need For Equity Capital: She said India needs capital, especially equity investment, to sustain growth, and that the government will consider investor feedback.  

What Is Foreign Portfolio Investment?

FPI vs FDI

Regulatory Framework

• SEBI (FPI) Regulations, 2019: These regulations govern FPI registration and investment limits.  

• Voluntary Retention Route (VRR): Introduced by the RBI in 2019, it offers relaxed rules to FPIs who commit to keep money in Indian debt for a minimum period. 

• Fully Accessible Route (FAR): It allows FPIs to invest in specified government securities without limits. It helped India's inclusion in the JP Morgan GBI-EM bond index in 2024.  

Why Are FPIs Leaving India?

Global Factors

• High US Yields: High returns on safe US government bonds draw capital away from emerging markets. 

• Strong Dollar: A stronger dollar reduces the dollar value of returns from Indian assets. 

• Geopolitical Shocks: The West Asia conflict raised crude oil prices above $100 a barrel, worsening India's inflation and current account outlook. 

• AI-Driven Rotation: Global investors have shifted money towards AI-heavy markets such as the US, Taiwan and South Korea. 

Domestic Factors

• High Valuations: Indian stocks have looked expensive relative to earnings growth compared with other markets. 

• Rupee Weakness: A falling rupee cuts dollar returns, prompting further selling and creating a cycle.  

• Tax Burden: The 12.5% long-term capital gains (LTCG) tax and the Securities Transaction Tax (STT) reduce post-tax returns.  

What Tax Changes Are Being Discussed?

Current Equity Taxes

• LTCG Tax: Gains on listed equity held over 12 months are taxed at 12.5% above an exemption of ₹1.25 lakh, as revised in Budget 2024. 

• Short-Term Capital Gains Tax: Gains on equity held for less than 12 months are taxed at 20%.  

• Fiscal Importance: LTCG tax on equities brought in about ₹1.29 lakh crore in assessment year 2025–26, nearly double the previous year.  

Recent And Proposed Steps

• Relief On Government Bonds: In June 2026, the government announced tax relief on FPI investment in government securities to support bond inflows and the rupee.  

• Budget 2027 Review: The government is reviewing LTCG and STT ahead of Budget 2027.  

• Calls For Abolition: SBI Research has proposed scrapping LTCG tax on equities to anchor foreign capital.  

Why Are Tax Cuts Alone Not Enough?

• Global Drivers Dominate: Outflows are driven mainly by US yields, the dollar, oil prices and valuations, which tax cuts cannot change.  

• Unfair To Domestic Investors: Special tax breaks for foreign investors could discriminate against domestic rupee investors, who pay the same taxes.  

• Avoid Capital Controls: The government should not respond by restricting domestic investors' outflows, such as those under the Liberalised Remittance Scheme. 

• Fiscal Cost: Cutting LTCG would mean losing significant revenue at a time of fiscal pressure.  

Lessons From The Past

• Tax Rollbacks Have Limited Effect: Past tax reversals offered only short-term relief.  

• Example: In 2019, the government rolled back an enhanced surcharge on FPIs after they withdrew over $3 billion in two months. The rollback calmed markets but did not change the global factors behind later outflows.  

What Are The Key Challenges?

External Vulnerability

• Sudden Stops: Volatile FPI flows can reverse quickly, putting pressure on the rupee and markets. 

• Example: During the 2013 "taper tantrum", when the US Federal Reserve signalled an end to bond buying, FPIs pulled money out of India and the rupee fell sharply. India was then grouped among the "Fragile Five" economies. 

The Impossible Trinity

• Policy Trade-Off: A country cannot have a fixed exchange rate, free capital movement and an independent monetary policy all at once. The RBI must balance rupee stability, open capital flows and interest rates.  

Rising Current Account Pressure

• Higher Oil Bill: Costly crude imports widen the current account deficit, which needs stable foreign capital to finance it.  

Way Forward 

Strengthen Fundamentals

• Macro Stability: Keep inflation, the fiscal deficit and the current account deficit under control to build investor confidence.  

• Earnings Growth: Strong corporate earnings and economic growth matter more to investors than small tax differences.  

Policy Certainty

• Stable, Predictable Taxes: Investors value tax stability over one-off cuts.  

• Example: The Taxation Laws (Amendment) Act, 2021 scrapped the retrospective tax provision linked to the Vodafone and Cairn disputes, which improved India's image on tax certainty.  

• Simpler Tax Law: The new Income-tax Act, 2025, in force from April 2026, aims to simplify tax rules and reduce disputes.  

Deepen Markets

• Strong Domestic Investors: Growing SIP inflows and domestic mutual funds have absorbed much of the FPI selling, cushioning markets.  

• Ease Of Investing: Simplify FPI registration, KYC and compliance rules.  

• Attract Long-Term FDI: Focus on stable FDI through manufacturing incentives such as the PLI schemes. 

Fair Tax Design

• Equal Treatment: Any tax relief should apply to both domestic and foreign investors.  

Conclusion

FPI outflows reflect global forces such as high US yields, a strong dollar and costly oil as much as Indian taxes. Lasting inflows will come from stable macro fundamentals, policy certainty and deep markets, not from tax cuts that favour foreign investors over domestic ones.

Source: INDIANEXPRESS