India plans to significantly reduce the tax rate on foreign investors' bond investments to curb rupee depreciation.

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India is considering a significant reduction in the taxes required for foreign investors holding domestic bonds, aiming to attract capital inflows, curb the continued depreciation of the rupee, and align India’s tax policy with global standards.

According to media reports, the Reserve Bank of India has made recommendations on this matter, and the Ministry of Finance is currently seriously evaluating related proposals. Media, citing informed sources, stated that since authorities are eager to curb the rupee’s decline, negotiations to reduce the tax burden on foreign investors have noticeably accelerated recently, but requested anonymity as the details remain confidential. Neither the Ministry of Finance nor the central bank have responded to requests for comment.

After the news broke, the rupee reversed its losses and bond prices rose. The yield on India’s 10-year government bond fell by 5 basis points to 7%, before rebounding slightly.

Edwin Gutierrez, head of emerging market sovereign debt at Aberdeen Investments, is cautious about the development. He said the move is "slightly positive, but not enough to reverse the overall negative sentiment in the Indian bond market," and pointed out that inflation pressures are the main reason why foreign capital continues to avoid Indian bonds.

The Rupee Under Pressure, Capital Inflows Plummet

So far this year, the rupee has been the worst-performing currency in Asia, with a cumulative drop of over 6% against the US dollar. To curb the depreciation, Indian authorities have so far mainly implemented defensive measures such as restricting trading position sizes.

Meanwhile, the Iran war has pushed up oil prices, expanding India’s import bills and increasing the urgency to attract foreign capital inflows to fill the funding gap. Data shows that due to war risks, foreign purchases of Indian bonds have shrunk significantly.

High Tax Burden, Low Share of Foreign Holdings

Under the current tax regime, foreign investors are required to pay about 20% tax on bond interest income. Previously, this rate was only 5%, but that preferential policy ended in 2023. Depending on holding period and the investor's jurisdiction, foreign investors must also pay short-term or long-term capital gains taxes, and some countries may enjoy lower rates under bilateral tax agreements.

Compared with other emerging markets such as Indonesia, Malaysia, Mexico, and South Africa, foreign investors generally report that India’s tax burden is high. Although Indian government bonds have been included in mainstream indexes such as JPMorgan and FTSE Russell, the share of foreign holdings is still only 3%, extremely low in the $1.3 trillion sovereign bond market.

From a longer-term perspective, advancing tax policy alignment with the international market is seen as an important step in helping Indian Prime Minister Modi achieve the goal of making India a developed country by 2047.

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