India's Financial Competitiveness: Will Tax Cuts Revive Foreign Investor Sentiment?

Indian Equities Face Volatility as Global Investors Compare Valuations

Foreign institutional investor (FII) flows into Indian equities have remained volatile over the last year as global investors continue to compare India's valuations, policy environment, and after-tax returns with competing emerging markets.

Market experts believe that rationalizing long-term capital gains (LTCG) and short-term capital gains (STCG) taxes could help improve sentiment and make Indian markets more competitive. However, while many market participants support tax rationalization, some experts also caution that taxation alone may not be sufficient to revive sustained FII inflows unless broader macroeconomic conditions improve simultaneously.

Tax Rationalization: A Potential Game-Changer

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Market experts said reducing LTCG and STCG rates could improve India's relative attractiveness by increasing post-tax returns for foreign investors and narrowing the competitive gap with low-tax jurisdictions. Santosh Meena, Head of Research at Swastika Investmart, said that lower taxation would directly improve investor returns while enhancing India's positioning among global markets.

According to Meena, reducing LTCG from 12.5% and STCG from 20% would attract FII inflows by improving post-tax returns on Indian equities. It makes India more competitive versus low or no-tax markets like Singapore, Hong Kong, and UAE. He added that lower taxes could help reduce the "India tax premium" while boosting net dollar returns for long-term foreign investors such as sovereign wealth funds and pension funds.

Historical Precedent: India's Zero-LTCG Regime

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Akshat Garg, Head Research & Product at Choice Wealth, pointed out that India had already experienced a long phase of strong foreign participation when LTCG tax on equities was fully exempt between 2004 and 2018. "Between 2004 and 2018, India exempted long-term capital gains on equities entirely. The Kelkar Committee pushed that exemption specifically to draw foreign institutional investors, and Indian markets emerged among the strongest emerging market stories globally," Garg said.

Taxation: A Key Factor in Global Portfolio Allocation Decisions

Vinit Bolinjkar, Head of Research at Ventura, argued that taxation remains an important factor in global portfolio allocation decisions. "India's capital gains tax structure on listed equities remains among the more expensive in the Asia-Pacific peer set, and this has increasingly become a friction point in relative allocation decisions by foreign institutional investors," Bolinjkar said.

Tax Cuts Alone May Not Be Enough

While experts broadly acknowledged the benefits of tax rationalization, some also warned that FIIs consider a much wider set of macroeconomic and structural variables before allocating money to emerging markets. Pranay Aggarwal, Director and CEO of Stoxkart, said that a reduction in LTCG and STCG rates would certainly be viewed positively, but alone may not materially alter foreign investment flows unless accompanied by stronger economic fundamentals.

Aggarwal noted that concerns around moderating earnings growth, premium valuations relative to emerging market peers, rupee depreciation due to elevated crude oil prices, and weaker foreign direct investment inflows continue to influence foreign portfolio investor sentiment toward India.