India to drop capital gains tax for foreign investors in government bonds

MUMBAI (June 4): India plans to scrap capital gains tax on foreign portfolio investments in government securities, which could help boost such inflows, a source familiar with the matter said on Thursday.

The South Asian nation is looking to attract foreign capital to counteract pressure on its rupee currency, which has weakened more than 5% since the start of the year, squeezed by higher oil prices and foreign portfolio outflows in equities.

The Economic Times newspaper was the first to report Wednesday's cabinet approval of the plan. The finance ministry did not immediately respond to a Reuters email seeking comment.

India's benchmark bond yield eased one basis point to 7.01% in opening trade, although it was not immediately clear when the plan would take effect.

Any tax easing should help flows at the margin, said Madhavi Arora, chief economist at Emkay Global Financial Services.

"It won't be a magic bullet in the current context," she cautioned, but added it could prove positive in the medium term.

Foreign investors are subject to a long-term capital gains tax of 12.5% on listed shares and bonds held longer than 12 months. A withholding tax of 20% they pay on interest earned in government bonds may also be removed, the source said.

India stands more or less in line with global standards on equity taxation, but is among the few countries that tax non-resident flows into debt, said the source, who sought anonymity as the decision is confidential and not yet made public.

Foreign investors have maintained net positive flows into Indian government debt this year, investing US$1.4 billion, but nearly US$28 billion has been pulled from equity markets.

Over the last few years, India has scrapped investment limits on a certain set of securities under a so-called "fully accessible route", in its effort to lure more foreign capital.

That helped it gain entry to key global bond indices such as the JPMorgan Emerging Market Bond Index and the Bloomberg emerging market local currency bond index.

In January, Bloomberg deferred a decision to include India in its more widely tracked Global Aggregate Index — a decision likely to come up for review in June.