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Informist, Friday, May 15, 2026

 

 

--Govt source: Got mkt's proposal to cut withholding tax on gilts to woo FPIs

--Govt source: Mkt seeks cut in gilts' withholding tax to 5% vs 20%, even nil

--Govt source: Tough to slash withholding tax on gilts for FPIs to nil 

--Govt source: Nil withholding tax for FPIs disadvantageous to local investors

--Govt source: Want to avoid changes to capital gains tax to attract FPIs

--Govt source: Hope steps taken so far aid FX reserves, help avoid tax tweaks

 

By Priyasmita Dutta

 

NEW DELHI - The Reserve Bank of India and the finance ministry have received proposals from market participants to lower the withholding tax rate on government bonds to attract foreign investment and help protect its foreign exchange reserves. The proposals come as India navigates one of its worst energy crises stemming from the war in West Asia.

 

The proposals include lowering the withholding tax from the current 20% to 5%, with some even seeking reducing it to nil, a senior government official said Friday. Slashing the withholding tax to nil, however, puts domestic investors at a disadvantage, the official told Informist. 

Withholding tax is a tax deducted at source and is paid by foreign investors on interest income from their holding of Indian bonds. At present, non-residents pay a withholding tax of about 20% on the interest earned, after the government hiked the concessional rate of 5% in June 2023.

 

"The ministry has heard about the proposal...reducing it to nil may be ruled out since that puts domestic investors at a disadvantage," the official told Informist. Domestic investors' interest income from investments in government bonds is subject to applicable income tax slab rates, which can be a maximum of 30%.

According to the official, the finance ministry will do a "360 degree" analysis before taking any decisions since a few policymakers are unsure if these measures will actually translate into higher investment inflows amidst the current global economic scenario. "Tax changes are tricky, and the government will be cautious about it," the official said. "The government cannot take a rushed call as it will be tough to roll back any changes overnight," the official added.

 

India is facing a severe energy crisis as it has been exposed to energy supply and price shocks, given its dependence on countries in the Persian Gulf region for crude oil, liquefied petroleum gas, and liquefied natural gas supplies. Crude oil prices have soared by around 60% following the closure of the Strait of Hormuz since early March. Nearly half of India's crude and natural gas imports pass through this crucial waterway. 

 

Given this situation, India's rupee has been hitting successive record lows, prompting the central bank to aggressively intervene in the market to limit its fall. India's foreign exchange reserves were at $690.69 billion as of May 1, almost $38 billion lower than the record high just before the war started. Since the war started on Feb. 28, the rupee has fallen almost 6% against the dollar, hitting a new lifetime low of 96.14 Friday. 

 

So far in 2026, FPIs have pulled out $21.76 billion from Indian markets, almost double the $10.92 billion they pulled out in the whole of 2025. In April, FPIs withdrew almost $6 billion worth of funds from the domestic market, and if a peace deal between the US and Iran is not brokered this month as well, market participants expect outflows to continue at a similar pace.

 

Prime Minister Narendra Modi has already announced "austerity measures" to protect India's forex reserves, including curbing gold imports via import limits and higher duties. Modi has also urged Indians to increasingly depend on metro rail, railways, and public transport to cut down on the use of petrol and diesel. The prime minister also said gold purchases and international trips must be pushed back by at least a year, given the energy crisis. 

 

Beyond government bonds, FPIs invest heavily in Indian equity markets as well, where the government administers short-term and long-term capital gains tax. According to the government official, the outflows seen so far cannot be linked entirely to the Indian taxation system, and so a cut in capital gains tax may not elicit inflows. "FPI outflows are typically seen when economic conditions become difficult...capital gains tax change will have limited impact in containing it," the official said while broadly ruling out the possibility of a change. 

 

India applies capital gains tax on FPIs if the asset is located in India, with provisions for relief under tax agreements with other nations, called double taxation avoidance agreements. This agreement, popularly called DTAA, is a bilateral tax treaty signed between two or more countries to prevent the same income from being taxed twice, once in the country where it is earned and again where the taxpayer resides. 

 

According to the official, the government will hold extensive discussions within the department, other ministries, and the RBI before taking any decision. "We are hopeful that the measures undertaken so far will help save FX reserves so that tax changes can be avoided," the official said.  End

 

US$1 = INR 96.07

 

With inputs from Pratiksha

Edited by Vandana Hingorani

 

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