Pull it, not just for better FPIs: Scrap FPI capital gains tax to boost inflows, strengthen rupee and cut fiscal deficit

Sebi's recommendation that GoI scrap long-term capital gains (LTCG) tax is welcome. It would improve FPI flows, strengthen rupee and help trim fiscal deficit.

Consider this: at FY26 prices, every 1% rupee appreciation would cut fuel and fertiliser subsidies by ₹13,000 cr. A 3-4% appreciation could save ₹50,000 cr a year, and surely even more at today's prices, comfortably exceeding our estimate of GoI's capital gains tax (CGT) collection from FPIs.

Will removing one tax really move the rupee? Evidence says it can. Over 22 yrs till June 2026, FPI equity plus debt inflows have totalled $257 bn, nearly half the cumulative change in India's BoP. Yet, the rupee slid from 46 to 95 against the dollar, principally due to the India-US interest-rate gap, which we stripped out first.


We then ran a multiple regression on 88 quarters of rupee movements against the 3 pillars of BoP: current account, FPI flows, and other capital flows. FPI flows proved to be the best correlated.

The results are striking in quarters with large volume FPI flows. In the 22 heaviest FPI outflow quarters, averaging $6.8 bn, the rupee fell 2.08%. In the 22 strongest inflow quarters, averaging $12.3 bn, it rose 2.26%.

Across these 44 quarters, absolute FPI flows averaged was 1.8% of GDP. FPI flows and rupee moved together 75% of the time, with 0.57 correlation (0.51 across all quarters), which is strong considering the multiple BoP components involved. The regression predicted that in these extreme quarters, rupee would move by 1.9% relative to trend per $10 bn of flows. A level of 1.5% should be appropriate.

Scrapping FPI CGT can trigger significant inflows. Indian CGT is often a double tax: most investors cannot offset it at home, and pension and sovereign funds have no home tax to offset it against.

Consider an investor with a 5-yr horizon earning 13% a year in Indian equities, the historical 10-yr Nifty EPS CAGR. After assuming 30% annual turnover and 4% annual rupee depreciation, Indian CGT plus home-country tax shrink this to just 4.9% a year in dollars. Without Indian CGT, this rises to a relatively strong 7.2%.

FPIs have repeatedly explained to us that ETFs tracking India trail their benchmark indices more than in most markets, and that obstructs new India mandates.

FPIs have pulled out about $77 bn over the past 24 mths and still have $690 bn invested. Assuming inflows of only 0.5-0.75% of annual GDP, CGT removal could bring in $20-30 bn, or trim outflows by that much. That would lift the rupee by 3-4% relative to its trajectory.

The fiscal deficit would improve. In FY26, India imported about $135 bn of crude, related products and fertilisers. At today's prices, that would be at least 20% more. Because the government ultimately absorbs oil companies' overruns and pays fertiliser subsidies, a stronger rupee would cut these costs and help narrow the fiscal gap.

Further, CGT collections fluctuate with markets, and CGT from FPIs could shrink as the market correction erodes taxable gains. Subsidy savings from a stronger currency, however, will endure.

Stronger inflows would also lift valuations, improving the government's disinvestment proceeds. Over time, a lower cost of capital would enable faster growth and a broader, deeper tax base.

Given these benefits, FPI CGT removal will pay for itself almost immediately. Even so, for revenue and political neutrality, securities transaction tax (STT) increases can help.

Both STCG and LTCG should be removed.

Removing only LTCG would prolong the double-tax friction and its impact on expected FPI returns, plus the impression of policy instability that FPIs carry. A complete break would send a strong message of commitment from GoI.

There are no guarantees in a complex world. But this could be a watershed moment, if India seizes it. This is not about India exercising its sovereign right to decide tax policy, and whether foreign investors deserve relief. It is about whether India can capitalise on the chance to enable stronger inflows, a steadier rupee, smaller subsidies, richer disinvestment proceeds and fiscal gains.

India has made remarkable progress through major reforms in the last decade. This is an excellent opportunity to accelerate. Cut capital gains tax on FPI equities immediately, comprehensively and permanently.

The writer is head of research, IIFL Capital Services, Mumbai