The Indian government and the Reserve Bank of India (RBI) have coordinated policy moves aimed at improving foreign exchange inflows, strengthening the rupee, and achieving a long-term objective of deepening the government securities (G-sec) market. The measures are designed to attract larger and more stable investors, broadening the investor base beyond the current dominance of banks and financial institutions.
Long-Standing Discussions Culminate in Policy Action
Officials familiar with the deliberations revealed that discussions had been ongoing for several months, with heightened intensity over the last eight to ten weeks. The central bank and the government engaged in detailed consultations based on feedback from investors. The need to review the tax framework became increasingly pressing as India pursues inclusion of its bonds in major global indices, such as the Bloomberg Emerging Market Local Currency Government Bond Index.
Tax Reforms to Enhance Attractiveness
Under the previous regime, foreign portfolio investors (FPIs) faced a long-term capital gains tax of 12.5% on listed shares and bonds, along with a withholding tax of 20% on interest earned from government securities. Investors had complained that this structure reduced the effective post-tax yield relative to comparable sovereign instruments. The government has now addressed these concerns by exempting interest and capital gains for the Bank for International Settlements (BIS) from investments in government securities. This move is expected to facilitate investment from global central banks, which are viewed as long-term and stable investors.
Expected Benefits for the G-Sec Market
Officials anticipate that deeper participation by foreign institutional investors (FIIs) will improve liquidity and price discovery in the government securities market over time. This will benefit all market participants, including domestic banks, insurance companies, and provident funds. A more liquid secondary market is also expected to reduce the cost of government borrowing on a sustained basis. Following the twin announcements on Friday, the rupee appreciated by 0.9% to close at 94.95 against the US dollar. Banks expect inflows of $25-30 billion or more due to these steps.
Path to Global Bond Index Inclusion
The government has been actively working toward inclusion of its bonds in global bond indices. The tax reforms are seen as a critical step in this direction. Officials are hopeful that Indian government bonds will now be included in more bond indices, further attracting foreign capital and deepening the market.
