Foreign Investors Surge into Indian Bonds: $1.84 Billion Inflows Driven by Tax Reform

Foreign Investors Surge into Indian Bonds: $1.84 Billion Inflows Driven by Tax Reform​

Foreign institutional investors (FIIs) have decisively abandoned the sidelines, driving a massive inflow of capital into India's debt market. So far in June, FIIs injected $1.84 billion into Indian government bonds across just five trading sessions—a sharp reversal after remaining largely inactive for over a year.

The recent surge signals a fundamental shift in foreign investor sentiment toward the nation's fixed-income instruments. This substantial inflow is primarily attributed to the Government of India’s critical policy decision on June 6th regarding capital gains taxes.

Policy Shift Sparks Record Inflows into Indian Debt​

The government's move scrapped both long-term and short-term capital gains tax on FII investments in government bonds. Furthermore, it eliminated the withholding tax on interest income from these debt instruments.

Previously, foreign investors faced significant tax burdens, including 12.5 percent on long-term capital gains and 30 percent on short-term capital gains. The elimination of these taxes has made the bond market significantly more appealing to global money managers.

Experts estimate that this sweeping policy change is poised to attract tens of billions of dollars into government debt over the coming years. This inflow could substantially help bridge economists' estimates for the balance of payments deficit, which could touch $60 billion in 2026-27.

Market Rebalancing and Domestic Stability Drive Rally​

The market response to this policy intervention has been swift and positive across the board. The Indian rupee has strengthened nearly 1 percent as of June, reversing a difficult trend after it had weakened 5.4 percent between January and May.

Bond yields have also shown a significant easing trend. The benchmark 10-year yield has fallen by nearly 13 basis points in June to 6.87 percent, down from 7 percent at the end of May. This reflects strong underlying confidence in government stability.

Shorter-tenor bonds are experiencing an even steeper rally. The 5-year yield has dropped 40 basis points and the 3-year yield has declined 38 basis points, reversing much of the sharp rise seen during January to May.

Expert View: Tax Reform and Geopolitical Calm Factor Inflows​

Analysts suggest that this turnaround is a combination of domestic policy enhancements and improving global tailwinds. Soumyajit Niyogi, Director at India Ratings, pointed to two key factors contributing to the reversal.

First, the new tax treatment has made the investment trade substantially more attractive. Second, eased geopolitical tensions in the Middle East have pushed oil prices lower, positively enhancing the broader macroeconomic environment for Indian debt.

Niyogi also noted that the removal of both capital gains and withholding taxes has effectively rebalanced the spread between Indian and US yields, making Indian bonds a highly compelling destination once again.

Expanding Investor Access and Future Outlook​

The Reserve Bank of India (RBI) has also played a constructive role in supporting the market structure. The RBI expanded the universe of government securities eligible under the Fully Accessible Route (FAR). It also introduced forex swap measures for overseas borrowings and FCNR deposits.

Radhika Rao, Senior Economist at DBS Bank, noted that these combined bond-supportive measures, including tax breaks and widening available securities, provide ample headroom for further incremental foreign flows.

Kunal Sodhani of Shinhan Bank added that while volatility is likely, the structural case for Indian debt remains constructive. This includes ongoing demand for FAR securities and relatively high real yields.

Sodhani concluded that FII debt flows are expected to remain positive in the medium term, even if they fluctuate with changes in global risk appetite or interest rate expectations.