Budget 2026: Indian Stock Market Seeks LTCG Tax Relief Amid Sustained FPI Exodus
As Budget 2026 approaches, there is growing clamor within the Indian stock market for a significant reduction in the long-term capital gains (LTCG) tax. This demand emerges against the backdrop of sharp underperformance by Indian equities over the past year, driven largely by relentless selling from foreign portfolio investors (FPIs).
India's Market Underperformance vs. Asian Peers
While the BSE Sensex managed to extend its annual bull run to a remarkable tenth consecutive year in 2025, posting a gain of nearly 9%, this return paled in comparison to several Asian markets. Key regional indices, including Pakistan's KSE 100, delivered substantially higher returns ranging from 16% to 68% during the same period.
Analysts emphasize that India's relative weakness last year was not fundamentally driven but rather stemmed from sentiment issues and a significant shortfall in foreign capital inflows. The market witnessed a record FPI selloff in 2025, a trend that has persisted into the current year amid multiple headwinds:
- A weakening Indian rupee
- Continued uncertainty surrounding an India-US trade deal
- Slowing corporate earnings growth
The Scale of Foreign Investor Withdrawals
According to data from the National Securities Depository Limited (NSDL), FPIs have been net sellers of Indian equities to the tune of ₹33,598 crore in January alone. This represents the highest monthly outflow since August 2025.
The broader picture for 2025 reveals even more substantial withdrawals, with total FPI selling hitting ₹166,286 crore as foreign investors remained net sellers in eight out of twelve months. The sustained pressure this year contributed to a 2.5% decline in the Nifty for the week ending January 23rd, erasing approximately ₹16 lakh crore in market capitalization within a single week.
Key Market Expectations for Budget 2026
In response to these challenges, market participants have outlined specific expectations for the upcoming budget. The primary focus is on measures to improve investor sentiment and attract foreign capital back to Indian shores. The central demands include:
- Reducing the LTCG tax rate from the current 12.5% back to 10%
- Rolling back the Securities Transaction Tax (STT) to encourage higher FPI participation
It is worth noting that the government reintroduced LTCG tax on equities in Budget 2018 at a 10% rate with a ₹1 lakh exemption. This was subsequently increased to 12.5% with a ₹1.25 lakh exemption limit in 2024, alongside a hike in short-term capital gains (STCG) tax from 15% to 20%.
Will Lower LTCG Tax Spur FPI Buying?
Market experts offer nuanced perspectives on whether tax reductions alone can reverse the current trend. Khushi Mistry, Research Analyst at Bonanza, argues that the demand for lower capital gains taxes merits serious consideration given 2025's market underperformance and foreign institutional investor (FII) outflows. She points to historical precedents, such as the post-2004 period following LTCG exemption, which saw a significant boost in retail participation.
However, analysts caution that while such a move would send a positive signal to long-term investors, it is unlikely to be a standalone trigger capable of reversing the ongoing FPI sell-off. A meaningful recovery, they argue, is contingent upon a broader earnings revival.
Harshal Dasani, Business Head at INVasset PMS, opines, "Even a modest cut in LTCG would improve post-tax returns at the margin, but it does not materially change the risk-reward equation for large offshore funds that allocate capital based on growth durability, liquidity depth, and macro stability."
Mistry concurs, noting that tax reductions could trigger short-term rallies through a sentiment lift, similar to post-2004 gains, but they cannot guarantee sustained bull runs in the absence of underlying earnings growth. "Tax tweaks aid, but macros and FII flows dominate," she summarizes.
Prerequisites for FPI Return: Earnings and Trade Deal
According to Dr. VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services, two critical factors must align to resume substantial FPI buying in India:
- A clear improvement in corporate earnings
- Progress on the long-awaited India-US trade deal
He suggests that the former is likely to materialize in the fourth quarter of the 2025-26 financial year. However, there remains no clarity whatsoever on the timeline for the latter, which the veteran market expert identifies as the single biggest uncertainty currently weighing on market sentiment.
Disclaimer: This analysis is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms. Investors are strongly advised to consult with certified experts before making any investment decisions.
