The government finally listened to the pleas of the stock and currency markets. Necessary steps have been taken to restore confidence among Foreign Portfolio Investors (FPIs) and Foreign Institutional Investors (FIIs) by abolishing the 12.5% Long Term Capital Gains Tax (LTCG) on Listed Government Securities (G-Secs). But a lot still remains to be done to strengthen the rupee. Foreign investors (both FPI and FII) have pulled out more than Rs 2.30 lakh crore from the Indian stock market between January and May 2026. So is this a sign of lack of confidence in the Indian economy? It’s not like that. But this is definitely a clear warning to the Finance Ministry about the necessary reforms in its tax structure. The outflow of foreign capital from India’s stock market is not only due to geopolitical disruptions. Our tax system is also responsible for this. India’s current account deficit is set to increase from 1% of GDP last year to 2% in 2026 due to rising costs of crude oil and LPG due to the Iran war. This is putting additional pressure on the rupee and the overall balance of payments (BOP). The rupee is facing a triple shock: oil, current account deficit and capital outflows by foreign investors. A fourth factor also exists – the challenge of AI. Although India is setting up manufacturing facilities (fabs) for semiconductor chips used in AI applications, it is still seen essentially as an AI-warehouse, where dozens of data centers consume gigawatt-levels of power to meet the needs of the West’s rapidly growing AI ecosystem. In such a situation, India may remain the only outsourced computing power vendor for the world’s AI industry. Until our own AI ecosystem matures, this perception will also impact the valuation of Indian stocks. In such a situation, reforms made for foreign investors in government securities and listed bonds will help in reviving global interest in our growth story. India needs decisive, not half-hearted, tax reforms that are both fiscally prudent and reassure FPIs and FIIs that India is an attractive and credible investment destination to satisfy foreign portfolio investors. LTCG was unwisely increased from 10% to 12.5% in 2023 for both Indian and foreign investors. Now it should be reduced to 5% for listed shares and bonds. The total tax revenue derived from LTCG on shares (except real estate) will be around Rs 35,000 crore. India’s total annual tax revenue is approximately Rs 40 lakh crore. In this, approximately Rs 22 lakh crore is received from corporate and personal income tax. Additional revenue of about Rs 18 lakh crore comes from indirect taxes (GST, customs and excise duties). Thus, reducing LTCG tax on listed shares from 12.5% to 5% will burden the exchequer by less than 0.5% of the total tax revenue. But this will impact both FPIs and Indian investors investing through SIP. The rapid growth in business will compensate for the minor revenue loss due to LTCG tax. This will be a win-win deal for all parties. India’s growth story is still strong, but global capital looks for profitable opportunities. There are 8,367 listed companies in BSE and NSE together. Of these, more than 1,000 are high-quality stocks, which attract foreign investors. Practical tax policies will have to be adopted to attract foreign portfolio investors back to India. Just reducing LTCG to 5% would give us an edge over China, which imposes a 10% long-term capital gains tax on foreign portfolio investors. It should also be remembered that from 2004 to 2018, the long-term capital gains tax on listed stocks in India was zero. It was increased to 10% in 2018 and then to 12.5% in 2023. We have to compete with the world wisely. As geopolitical tensions ease, oil prices decline, the rupee stabilizes and our AI ecosystem matures, foreign portfolio investors will return. (These are the author’s own views)
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Minhaj Merchant’s column: Growth story is still strong but focus on investment is necessary
