The Indian government introduced an exemption on income tax on interest and capital gains on investments made by Foreign Portfolio Investors (FPIs) in Government Securities (G-Secs) as early as June 2026 with retroactive effect from 1 April 2026. The amendment was implemented via the Income Tax (Amendment) Ordinance, 2026, and addressed a long-standing tax concern raised by foreign investors that had prevented many international investors from investing in the government securities market in India. The exemption only applies to foreign investors, but retail investors in bond markets in India need to be aware of this change.
What Changed Under the 2026 FPI Tax Exemption?
In the previous arrangement, there was a withholding tax of 20 per cent charged on the interest earned on G-Secs and 12.5 per cent capital gains tax charged on FPIs once they have held on to the G-Secs for more than one year. However, in the recent amendment through the Income Tax Amendment Ordinance, 2026, issued on 5th June 2026, these two taxes have been exempted to FPIs that invest in G-Secs, on condition that they provide the required information. There is an equivalent tax exemption enjoyed by the BIS in regard to their investment in G-Secs.
This measure has come at a time when RBI and the Department of Economic Affairs have made other announcements related to making participation in the sovereign debt market of India by global capital easy and profitable. This includes the widening of Fully Accessible Route (FAR) to include new issues of 15 years, 30 years and 40 years G-Secs and removal of security-wise investment limits for FPIs (maximum 6 per cent limit on outstanding G-Secs of Central Government continues to be the same).
Why is India Encouraging More Foreign Investment in Government Bonds?
India's government borrowing needs are large, and the bond market has traditionally relied heavily on domestic banks, insurance companies and provident funds to absorb this supply. A narrow investor base can mean lower liquidity and higher borrowing costs during periods of heavy issuance. By making G-Secs more attractive to long-term global investors such as pension funds, sovereign wealth funds and insurers, the government aims to:
- Deepen the bond market and widen the investor base
- Improve secondary market liquidity
- Reduce dependence on domestic institutions for absorbing government debt
- Strengthen India's case for larger weight in global bond indices, following its earlier inclusion in indices such as JPMorgan's GBI-EM
Tax was widely seen as the single biggest roadblock to fuller index-linked inflows, so removing it is a structural, rather than a one-off, change.
How Could Higher FPI Participation Influence G-Sec Yields?
In principle, higher foreign demand for G-Secs pushes bond prices up and yields down, since bond prices and yields move inversely. Between 24th to 30th July, the benchmark 10-year G-Sec yield has been trading broadly in the 6.7%–6.8% range, with some sessions closer to 7.1%, reflecting the pull between improved FPI sentiment and other pressures.
However, the extent of any yield decline depends on several other forces working at the same time:
- RBI monetary policy: The repo rate has stood at 5.25% through much of 2026, and any change feeds directly into short and long-term yields.
- Inflation: Crude oil price swings have been a key driver, with Brent prices ranging from the mid-$80s to over $100 a barrel during the year, directly affecting inflation expectations.
- High government borrowing: Heavy issuance in a given quarter can offset the demand boost from FPIs.
In short, the tax exemption improves the demand side, but yields remain a function of the full macro picture, not the exemption alone.
Will Corporate Bond and NCD Yields Change Too?
Corporate bond and NCD pricing in India is built on top of the G-Sec yield curve, with an additional "credit spread" that reflects the issuer's creditworthiness. If sovereign yields ease due to stronger FPI demand, the benchmark curve shifts lower, and well-rated corporate issuers can typically refinance at somewhat lower coupons, since their pricing is anchored to the sovereign curve plus a spread.
Recent market data illustrates the spread structure: PSU AAA-rated paper has been trading roughly in the 7.0%–7.5% band, while AA-rated public NCD issues have offered coupons closer to 8.4%–9.5%, and state government bonds (SDLs) have priced around 25–40 basis points above comparable G-Secs. High-quality PSU and AAA corporate issuers, which are more sensitive to sovereign benchmark movements, are likely to see the most direct transmission. Lower-rated issuers may see a smaller effect, since their spreads are driven more by company-specific credit risk than by the sovereign curve.
What Does This Mean for Retail Bond Investors?
Retail investors do not receive the FPI tax exemption themselves the 12.5% LTCG tax rate for domestic investors, including G-Sec gains, remains unchanged. But there are indirect effects worth watching:
- Existing bond holdings: If G-Sec yields ease, the market value of previously issued bonds with higher coupons can rise, offering potential capital appreciation to existing holders of G-Secs, SDLs and PSU bonds.
- New issuances: Lower benchmark yields could mean that new NCDs, PSU bonds and small savings-linked products are launched with somewhat lower coupons over time.
- Debt mutual funds: Funds holding long-duration G-Secs and PSU bonds could see NAV gains if yields fall, though this is not guaranteed.
Retail investors should treat this as a favourable but gradual backdrop rather than an immediate benefit.
Could There Be Any Risks or Limitations?
FPI flows into any emerging market, including India, are known to be volatile. Several factors could limit or reverse the intended effect of this exemption:
- Global interest rates: The rates on US Treasuries, which hover around 4.6%-4.7% as of July 2026, influence the comparative value of Indian bonds.
- Currency fluctuations: The falling rupee can undermine the gains offered by high domestic yields and a lower interest among foreign investors despite the tax reduction.
- Geopolitical developments: Fluctuations in the prices of oil linked to geopolitical instability in the region have already resulted in volatile Indian bond yields in 2026.
- Investment risk environment: A widespread sentiment to avoid risk in the world market may lead to capital outflows from India regardless of the reforms.
The tax exemption removes a structural disadvantage, but it does not guarantee permanently lower yields, since yields are set by many moving parts at once.
Key Indicators Investors Should Monitor
Retail bond investors tracking the effects of this reform should watch:
- RBI monetary policy decisions and the repo rate
- Retail inflation (CPI) trends
- The government's fiscal deficit and quarterly borrowing calendar
- Net FPI inflows/outflows into G-Secs
- The benchmark 10-year G-Sec yield
- Global bond yields, especially US Treasuries
- Corporate bond credit spreads over G-Secs
Conclusion
The 2026 FPI tax exemption on G-Secs is a part of India's longer-term effort to deepen its sovereign debt market, improve liquidity, and strengthen its standing in global bond indices. Retail investors will not benefit from the tax exemption directly, since domestic tax rules are unchanged. But they may still experience indirect effects through bond prices, benchmark yields, and overall market liquidity, as the reform plays out alongside RBI policy, inflation trends and global market conditions over the coming quarters.
Frequently Asked Questions
1. Does the FPI tax exemption apply to retail investors in India?
No. The exemption under the Income-tax (Amendment) Ordinance, 2026, applies only to Foreign Portfolio Investors and the Bank for International Settlements on their G-Sec investments. Domestic retail investors continue to pay tax on G-Sec interest and capital gains as before.
2. From when is the FPI tax exemption on G-Secs effective?
The exemption applies from 1 April 2026, though it was formally announced via an Ordinance on 5 June 2026.
3. Will this exemption reduce my home loan EMI or FD rates?
Not directly. Home loan and FD rates are more closely linked to the RBI repo rate. However, if G-Sec yields ease meaningfully over time, it could indirectly support a lower interest rate environment.
4. Which bonds could benefit most from this reform?
G-Secs directly, and by extension, high-quality PSU and AAA-rated corporate bonds, since their pricing closely tracks the sovereign yield curve.
5. Is a fall in bond yields guaranteed after this exemption?
No. Yields depend on multiple factors, including RBI policy, inflation, government borrowing and global bond market conditions, in addition to FPI demand.
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