Can cutting LTCG, STCG revive FPI flows? JM Financial, Bernstein answer

A reduction in LTCG tax would be desirable for a capital-starved economy but would not, by itself, trigger sustained foreign institutional investor (FII) inflows, said Venugopal Garre of Bernstein.

Scrapping or reducing capital gains tax on foreign portfolio investors (FPIs) could improve India's appeal to overseas investors, but is unlikely to trigger a meaningful revival in foreign inflows unless valuations become more attractive and the earnings outlook improves, according to an October 30 report by JM Financial.

 

While a cut in long-term capital gains tax (LTCG) or short-term capital gains tax (STCG) could boost post-tax returns and signal a more investor-friendly policy environment, taxation is not the primary driver of foreign portfolio flows, the brokerage said. Valuations, currency movements and relative opportunities across emerging markets are likely to matter more.

 

Bernstein shares this assessment. A reduction in LTCG tax would be desirable for a capital-starved economy but would not, by itself, trigger sustained foreign institutional investor (FII) inflows, said Venugopal Garre, managing director and head of India research at Bernstein, in an October 19 report. 

 

"A recovery in India's growth and earnings cycle remains critical. A sharp 1–2 day market rally that a cut would trigger may actually be used to offload positions," Garre said.  

 

 

According to a Reuters report, India's markets regulator, the Securities and Exchange Board of India (Sebi) has recommended the government remove the LTCG tax imposed on foreign investors. READ HERE

 

Currently, FPIs pay tax on realised capital gains from listed Indian equities in rupee terms. LTCG is taxed at 12.5 per cent and STCG at 20 per cent, excluding applicable surcharge and cess.

 

Tax relief versus revenue loss

 

Any move to scrap capital gains tax for FPIs would also need to account for the revenue implications, JM Financial analysts Venkatesh Balasubramaniam and Shanay Mehta said in the coauthored note. 

 

Meanwhile, equity LTCG tax collections stood at ₹1.29 trillion in FY25, equivalent to around 2.9 per cent of the Centre's budgeted gross tax receipts for FY27. The figure needs to be viewed against the government's fiscal deficit target of 4.3 per cent of GDP, the report said.

 

Historical evidence of the relationship between capital gains taxation and FPI flows is mixed. Small changes in tax rates have had limited influence on investment decisions, while sharp changes in the effective tax burden have triggered more visible responses, JM Financial said.

  

Scrapping LTCG tax could add around 2.2 percentage points to an average year's dollar returns for foreign investors, broadly offsetting the annual drag from rupee depreciation.

 

However, valuation changes can have a much larger impact. A one-time expansion of the market's price-to-earnings multiple by one turn could boost returns by 5.8 per cent. A re-rating from the current 17.1 times to the 10-year average of 21.3 times would imply a potential gain of 24.3 per cent, the brokerage estimated. 

 

 

JM Financial believes tax relief could therefore have a greater impact as a policy signal than as an immediate trigger for foreign inflows. A credible announcement in the February 2027 Budget, whether abolishing LTCG tax or revisiting holding-period requirements, could improve investor perceptions of India's investment climate. 

 

The brokerage estimates that such relief could add $3-5 billion to foreign inflows in FY28 under its bull-case scenario. It clarified that this is an analytical assessment rather than a formal model output. Investors with greater flexibility between dedicated India funds and benchmark-relative portfolios could respond more favourably.

 

Alternatives to scrapping LTCG

 

Rather than abolishing capital gains tax altogether, JM Financial has suggested taxing FPIs on dollar-denominated gains instead of rupee-denominated gains, or indexing acquisition costs to account for rupee depreciation.

 

This, it believes, could address instances where foreign investors incur a tax liability on gains in rupee terms despite making little or no return in dollars.

 

Other options include bringing the STCG rate closer to the LTCG rate or reducing the 12-month holding period required for long-term capital gains treatment for FPIs.