Lowering LTCG isn't a magic bullet

Measures such as lowering LTCG tax for domestic and foreign investors and allowing foreigners to pay the tax on gains in dollar terms will boost sentiment in the equity market. Returns have flatlined as foreign investors are pulling out of India because of a concentration of interest in AI infra, India's vulnerability to the West Asian energy shock and rising yields on US treasuries. Macroeconomic and corporate performance do not justify the magnitude of the FPI selloff. India's economy has moderated after a post-Covid recovery, but the investor reaction is disproportionately influenced by external uncertainties that the country is navigating well. LTCG on equities was reimposed in 2018 and its current rate was set in 2024. Investor behaviour must be mapped over the period as a guide to any review of the tax.

India is losing its tax competitiveness against other emerging markets - Hong Kong, Singapore, Taiwan and Indonesia - that do not tax LTCG on foreign investment in equities. Tax relief to foreign investors in government bonds introduced earlier this year caused a spike in inflows. Less structural friction could make Indian equities more lucrative, but FPI behaviour is being driven by more fundamental economic factors than tax policy. Even after the correction, Indian equities face strong competition from cheaper emerging markets. Tax treaties anyway provide FPIs with pathways to invest in India that are not influenced by tax changes.

GoI will be influenced by the revenue implications of a change to LTCG tax on equities as well as its impact on providing policy certainty to foreign investors. A middle ground could involve a structured reduction or a dollar-denominated tax framework. This will signal market friendliness while upholding fiscal propriety. A robust policy response would focus on restoring economic momentum and corporate earnings, which are the chief drivers of foreign investment flows. The external factors that are shaping global capital currently cannot be counteracted through tax policies of any one nation.