India Scraps Tax on FPI G-Sec Income and Capital Gains: The June 2026 Ordinance Explained

A Cascade of Simultaneous Shocks

To understand why the Indian government reached for an ordinance to amend its income tax law on the same day as a monetary policy announcement, it is necessary to understand the severity and simultaneity of the external pressures India was absorbing through the first five months of 2026.

The West Asia conflict that escalated sharply in late February 2026 set off a chain of consequences that compressed India’s external position from multiple directions at once. Brent crude oil prices, which determine the cost of roughly 90 percent of India’s energy imports, climbed into triple-digit territory. In April 2026, India spent $18.7 billion on crude oil imports alone. The monthly trade deficit reached $28.4 billion in April, up from $20.67 billion in March. These numbers translate directly into demand for US dollars in the foreign exchange market, weakening the rupee.

Simultaneously, the same geopolitical shock that was driving up India’s import bill was driving global investors toward safety in US assets. FPIs, who had already been net sellers of Indian equities in most months of 2025, accelerated their exit in 2026. January saw outflows of Rs 35,962 crore. February produced a brief inflow of Rs 22,615 crore, described at the time as the highest monthly inflow in 17 months. Then March delivered a record single-month outflow of Rs 1.17 lakh crore. April added another Rs 60,847 crore of net selling. May continued the trend. Total FPI equity outflows from India in 2026 reached Rs 2.2 lakh crore, already exceeding the entirety of 2025’s outflows of Rs 1.66 lakh crore.

The Forex Reserve Drawdown and the BoP Gap

India’s foreign exchange reserves reached an all-time high of approximately $728.49 billion in the week ended February 27, 2026. By the week ended May 22, 2026, they had fallen to $681.4 billion, a drawdown of roughly $47 billion in under three months. The RBI had been actively selling dollars through state-run banks across multiple trading sessions to prevent a sharper rupee collapse. The rupee touched a record low of 96.96 against the dollar before the RBI’s interventions provided a partial recovery.

Economists estimate India’s balance of payments deficit could reach $50 to $60 billion in FY27. Fresh foreign capital is needed to help bridge the widening gap in India’s external accounts. With the RBI already having sold a net $53.13 billion in the spot foreign exchange market during FY26 to defend the currency, the question for policymakers was no longer whether to act. It was which tools to use and in what sequence.

A Complete Elimination of Two Separate Tax Levies

The Income-tax (Amendment) Ordinance, 2026, published in the Gazette of India on June 5, amends the Income-tax Act, 2025. It inserts a provision exempting, in the case of a Foreign Institutional Investor, all interest income on government securities and all capital gains arising from the sale, exchange, transfer, or redemption of such securities. The ordinance defines Foreign Institutional Investor by reference to section 210(6)(a) of the Income-tax Act, 2025, and Foreign Portfolio Investors registered with SEBI are treated as FIIs for this purpose. A parallel exemption is extended to the Bank for International Settlements on the same terms.

Prior to this ordinance, foreign investors faced two separate tax costs on government securities. Interest income attracted a 20 percent withholding tax. Long-term capital gains on listed government securities, applicable on holdings of more than 12 months, were taxed at 12.5 percent, a rate that had been raised from 10 percent in the 2024 Budget. Short-term capital gains were taxed at 30 percent. Both categories are now eliminated for eligible foreign investors.

The exemption applies retrospectively from April 1, 2026. This retroactive effect is significant: it means FPIs who earned interest income or realised capital gains on government securities at any point during the 2026-27 financial year will pay no tax on those gains. It is not merely a prospective incentive for new investment. It also retroactively reduces the tax liability of existing holders, improving the net-of-tax return profile on positions they have already taken.

The ordinance was necessary because Parliament was not in session. The government invoked Article 123 of the Constitution, which allows the President to promulgate an ordinance when Parliament is not in session and immediate action is required. The use of this emergency legislative instrument signals that the government judged the timing too urgent to wait for the next parliamentary session.

Expanding the Fully Accessible Route to Longer Tenors

The RBI’s June 5 monetary policy statement included a set of capital-account measures designed to work in conjunction with the tax ordinance. The most significant was the expansion of the Fully Accessible Route, the channel through which foreign investors can buy Indian government securities without the restrictions that apply under the General Route. Previously, the FAR was concentrated in bonds with tenors up to 10 years. The RBI announced it would expand the eligible universe under the FAR to include all new issuances of 15-year, 30-year, and 40-year government securities.

This matters strategically because the investors the government most wants to attract, pension funds, insurance companies, and sovereign wealth funds, are precisely those with long-dated liability profiles that match the duration of 30 and 40-year bonds. These institutional investors were previously unable to access India’s longer end of the yield curve through the FAR. The expansion directly opens India’s sovereign debt market to a class of patient, low-turnover capital that is structurally less prone to the kind of sudden exit that has plagued India’s equity FPI flows in 2026.

Removing Three Restrictions Under the General Route

For FPIs investing through the General Route, the RBI removed three restrictions that had previously constrained participation: the short-term investment limit, the concentration limit on investments in individual securities, and the security-wise investment limit. The overall quantitative caps on General Route investment remain: 6 percent of the outstanding stock of central government securities and 2 percent of state government securities. The sub-categories of general and long-term investment limits under the General Route were merged into a single unified limit.

The rationale for removing these restrictions is the development of a smooth yield curve. When foreign investors are constrained by concentration and security-wise limits, they cannot freely express duration preferences across the curve. Removing these operational barriers allows foreign buyers to concentrate in the maturities they prefer, which should in theory improve price discovery and reduce artificial kinks in the yield curve.

Tax Revenue Sacrificed on the State’s Own Borrowing

The intellectual peculiarity of this move deserves examination. India is not exempting tax on private corporate bonds or equity market gains. It is exempting tax on its own sovereign debt. Every rupee of interest the government pays to a foreign investor on a government security is now fully tax-free for that investor. Every capital gain that investor makes by selling that government bond in the secondary market is also tax-free. The state is simultaneously the borrower and the taxing authority, and it has chosen to forgo the revenue it would have collected from taxing its own interest payments to foreign creditors.

The scale of this is material. As of May 12, 2026, FPIs held government securities worth approximately Rs 3.75 lakh crore, representing 3.34 percent of the total eligible outstanding G-Sec stock of Rs 112.42 lakh crore. Of this, Rs 3.21 lakh crore was held through the FAR and Rs 54,091 crore through the General Route. The current outstanding stock implies significant interest accrual annually. On a portfolio of Rs 3.75 lakh crore, a weighted average coupon in the region of 7 percent would generate approximately Rs 26,000 crore of annual interest income. At a 20 percent withholding tax, the annual revenue cost of the exemption on the existing portfolio alone is in the range of Rs 5,000 crore. As the portfolio grows toward the permitted limits, the revenue foregone scales proportionately.

The Sovereign Debt Dynamics at Stake

India’s fiscal deficit target for FY27 is approximately 4.2 to 4.4 percent of GDP, an improvement on the 4.4 percent target for FY26. The government’s medium-term goal is to reduce the central government’s debt from approximately 56 percent of GDP to 50 percent by 2031. Against that backdrop, the key transmission channel for the tax exemption into sovereign debt dynamics runs through the yield curve. Following the June 5 announcement, the yield on the benchmark 10-year government bond declined 3 basis points to 6.96 percent. That is a modest immediate reaction. The more important question is whether the structural opening of the G-Sec market to a broader and deeper pool of foreign buyers over 12 to 24 months reduces the yield premium India pays on its sovereign debt.

India’s inclusion in the JPMorgan Government Bond Index for Emerging Markets since June 2024 and the Bloomberg Emerging Market Index had already begun attracting passive foreign flows into Indian bonds. The tax exemption significantly improves the post-tax yield calculus for active managers and long-term institutional investors who were previously deterred by the complexity of withholding tax deductions and the requirement to file Indian tax returns. The measure facilitates Euroclear-style settlement structures and offshore portfolio rebalancing, making Indian bonds accessible in the same frictionless way that buyers access Treasuries or Bunds.

Four Features That Set This Apart

India has periodically liberalised its government securities market for foreign investors over the past decade. The FAR itself was introduced in 2020. Investment limits have been progressively raised. The J.P. Morgan index inclusion was a significant milestone. This move is different in kind, not just degree, for four specific reasons.

• The Ordinance Route
  Emergency legislation, not scheduled reform

  The government chose to amend income tax law through a presidential ordinance under Article 123 of the Constitution rather than waiting for Parliament. This reflects urgency at the highest level of the executive. Ordinances are rare instruments for tax policy. Their use here signals that policymakers judged the external sector situation as requiring faster action than the parliamentary calendar allowed.

• Retroactive Effect
  April 1, 2026 start date is not cosmetic

  By making the exemption retroactive to the start of FY27, the government effectively eliminated a tax liability that FPIs had already accrued during April and May 2026. This is unusual in tax policy. It improves the returns of existing holders immediately, without requiring them to take any new action, and signals that the government is willing to sacrifice tax revenue that it was already legally entitled to collect.

• BIS Inclusion
  Central bank of central banks gets the same treatment

  The Bank for International Settlements was explicitly granted an identical tax exemption in the same ordinance. This is a deliberate signal to the global official-sector investment community. It aligns India’s treatment of BIS with that of other sovereign debt markets and opens a pathway for official-sector liquidity to flow into Indian government bonds on entirely tax-neutral terms.

• Completeness
  Both interest and capital gains, all holding periods

  Previous Indian tax reliefs for foreign investors in bonds have typically been partial: a reduced rate here, an exemption for a specific category there. This ordinance eliminates every income tax cost associated with holding or trading government securities, across all holding periods and across both income streams. It is a complete fiscal clearance of the sovereign debt market for foreign investors, not an incremental improvement.

The Bull Case: A Structural Re-Rating of Indian Sovereign Debt

The most optimistic reading of the June 5 measures is that they trigger a structural re-rating of Indian government bonds in global fixed-income portfolios. The argument runs as follows. India’s G-Sec market is among the largest in the world in absolute terms, with an outstanding stock exceeding Rs 112 lakh crore. Foreign investors hold only 3.34 percent of that stock, an extraordinarily low share given India’s index inclusion and the scale of its domestic bond market. The gap between current foreign participation and the permissible limits under the General Route alone represents trillions of rupees of room to grow. Tax friction has been a documented barrier to this participation. Removing it should, over time, attract the global pension funds, insurance asset managers, and sovereign wealth funds that are the natural buyers of long-duration sovereign bonds in well-managed economies.

Conservative projections estimate the measure could attract approximately $45 to $50 billion of foreign investment into government bonds over two years. That is not a trivial number in the context of India’s external financing requirements. At current exchange rates, $50 billion of inflow into G-Secs would represent roughly Rs 4.8 lakh crore, more than doubling FPI holdings of government bonds from their current level. The yield compression that would accompany that volume of buying could meaningfully reduce the government’s borrowing costs.

The Bear Case: Tax Relief Cannot Solve Macro Instability

The less optimistic reading focuses on what the tax exemption cannot do. The proximate causes of FPI outflows from India in 2026 are geopolitical risk, elevated crude oil prices, a weak rupee, and a global investor preference for US dollar assets in a risk-off environment. None of these factors are addressed by improving the post-tax yield on government bonds. A foreign investor who is selling Indian equities because crude oil at $110 is widening India’s current account deficit and depressing corporate margins has not changed their view on India’s macro trajectory because interest on G-Secs is now tax-free.

The measures also address debt flows, not equity flows. The Rs 2.2 lakh crore that FPIs have pulled out of Indian equities in 2026 cannot be recaptured by making government bonds more attractive. These are different instruments held by different institutions for different purposes. The equity outflow represents a loss of confidence in India’s equity market valuations at current levels, which at approximately 21 times forward price-to-earnings, still appear expensive relative to North Asian markets on a risk-adjusted basis according to analysts at JM Financial and others.

The 10-Year Government Bond as a Barometer

The yield on India’s benchmark 10-year government bond declined 3 basis points to 6.96 percent immediately following the June 5 announcement, a positive but modest reaction. Both the RBI measures and the tax exemption are supportive of bond yields in the near term. Over the medium term, the bond yield will be the most important single indicator of whether the June 5 package is working as intended. If foreign participation in the G-Sec market broadens materially over the next two to four quarters and the 10-year yield drifts lower despite record gross borrowing, the fiscal trade-off will have proven its worth. If inflows disappoint and yields stay elevated or rise, the government will have sacrificed tax revenue without securing the capital it needed.

Disclaimer: This article is for informational and educational purposes only and is current as of June 9, 2026. Data is sourced from the Gazette of India (Extraordinary), the RBI Monetary Policy Statement (June 5, 2026), the RBI Annual Report 2024-25, the Income-tax (Amendment) Ordinance 2026 (Government of India), and official RBI press releases and circulars. Nothing in this article constitutes investment advice. Readers should conduct their own research and consult a qualified financial adviser before making investment decisions.