Tax Cuts Unlikely to be Panacea for Attracting Foreign Investment, Experts Warn

Foreign Institutional Investors Continue to Trim Exposure to Indian Equities

A growing debate has emerged among experts over whether reducing capital market levies such as long-term capital gains tax (LTCG), short-term capital gains tax (STCG), and securities transaction tax (STT) could help reverse the trend of foreign institutional investors (FIIs) trimming their exposure to Indian equities.

While experts broadly agree that lower taxes would improve India's attractiveness as an investment destination, many argue that taxation is only one piece of a much bigger puzzle. Factors such as India's lack of listed artificial intelligence (AI) opportunities, relatively expensive valuations, currency stability, earnings growth, and policy certainty may ultimately play a bigger role in determining long-term foreign capital flows.

According to National Securities Depository Limited (NSDL) data, total outflow by foreign investors from the Indian equity market has reached Rs 2.25 lakh crore so far in 2026, surpassing the Rs 1.66 lakh crore withdrawn during calendar year 2025.

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Tax Cuts Can Improve Competitiveness

Several experts believe India's tax regime makes the market less competitive compared to other investment destinations. Nitin Jain, CEO & principal fund manager at Kotak Mahindra Asset Management Singapore, said that India should remove frictions to investment by global investors and removal of capital gains is an important step towards that.

Taxation plays an important role in allocation, taxes not only impact returns, but also make it difficult for investors to outperform the benchmark indices. According to Jain, capital gains taxes are a bigger concern for foreign investors than STT.

High Trading Costs and the STT Debate

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The discussion around taxation has also reignited calls for a review of STT, particularly in derivatives markets. Nikhil Ranka, CIO- Equity Alternatives at Nuvama Asset Management, said that STT was originally introduced to compensate for revenue losses after LTCG was reduced to zero and STCG lowered in 2004. Over time, however, all three taxes have increased simultaneously.

According to Ranka, high transaction costs are affecting market liquidity and trading activity. He suggested that serious consideration should be given towards eliminating STT on futures and options (F&O) transactions.

AI Opportunities Drawing Capital Away from India

While taxes remain a key talking point, multiple experts identified the absence of large listed AI and semiconductor opportunities as a unique challenge facing Indian markets. Over the past two years, global equity markets have been dominated by AI-related investments, with capital flowing into technology, semiconductor, and computing infrastructure companies across the US, Taiwan, South Korea, and China.

Valuations, Currency, and Growth Matter Too

Experts also pointed to valuations, currency movements, and economic growth as important drivers of FII allocations. According to Hitesh Suvarna, macro economist at JM Financial Institutional Securities, stretched valuations relative to emerging market peers, coupled with concerns around energy prices and external vulnerabilities, have contributed to foreign outflows in recent quarters.

Policy Stability

While opinions differ on the effectiveness of tax cuts, experts broadly agree that long-term investors ultimately prioritize policy certainty and economic fundamentals. Policy stability provides certainty, and the lack of uncertainty attracts long-term capital, according to Suvarna.