India Expands FAR and Slashes Bond Taxes to Lure Foreign Capital Amid Forex Volatility

A dual-pronged strategy of tax exemptions and widened sovereign debt access seeks to stabilize the rupee and attract long-term global investment.

In a decisive move to bolster the country’s external position, the government has unveiled a comprehensive package designed to make Indian sovereign debt more attractive to global participants. By exempting foreign institutional investors (FIIs) from withholding taxes on interest and capital gains for government securities, alongside a significant expansion of the Fully Accessible Route (FAR), regulators are attempting to stem the tide of capital outflows that have pressured the rupee throughout 2026.

Widening the Investment Horizon

The Reserve Bank of India (RBI) has moved to deepen the bond market by adding 15-, 30-, and 40-year tenures to the FAR basket. This expansion covers new issuances of the 6.68% GS 2040, 7.24% GS 2055, and 7.71% GS 2066 papers, allowing eligible foreign investors to participate without quantitative limits. By removing previous concentration norms and short-term investment restrictions for foreign portfolio investors (FPIs), the central bank is effectively dismantling the regulatory hurdles that critics argued had long placed Indian debt at a competitive disadvantage against emerging market peers like Indonesia.

The fiscal shift is equally significant. Through an ordinance amending the Income-tax Act, effective April 1, 2026, the government has eliminated the 20% withholding tax on interest and the 12.5% long-term capital gains tax previously levied on these investments. For global funds, this move recalibrates the post-tax return profile of Indian government securities, signaling a clear departure from the restrictive tax regime that governed the market in recent years.

Market Reaction and Expert Caution

Initial market sentiment responded positively to the announcement, with 10-year G-sec yields briefly rallying before settling. However, analysts remain divided on whether these policy changes will trigger an immediate deluge of funds. Treasury executives point out that while the structural changes are welcome, the broader macroeconomic environment remains fraught with uncertainty. Elevated crude oil prices, spurred by the ongoing conflict in West Asia, and the resulting volatility in foreign exchange reserves continue to serve as a drag on investor appetite.

"We do expect inflows to come in, but the kind of large-scale flows that some market participants are anticipating may not materialize soon," noted Alok Singh, head of treasury at CSB Bank. While some estimates suggest these reforms could eventually attract $20-30 billion in capital, market watchers emphasize that geopolitical stability will be the ultimate arbiter of when and how heavily international capital returns to Indian shores.

Balancing Revenue and Growth

The government’s decision to sacrifice Rs 10,000-15,000 crore in potential tax revenue underscores the urgency of the current economic climate. With FPI outflows reaching $13.1 billion in March alone, the push to stabilize the rupee has become a priority that outweighs short-term fiscal collection goals. By aligning domestic policies with global standards, policymakers hope to dampen the currency's slide, which saw it touch record lows against the dollar earlier this year.

As India seeks to deepen its bond market and secure its place in global indices, these reforms represent a fundamental pivot. The success of this initiative will likely depend on whether the combination of tax relief and expanded market access can outweigh the risks posed by global oil shocks and lingering concerns over regional geopolitical tensions.