Govt has completely eliminated capital gains tax and withholding tax on interest income for FPIs investing in GSec, and has expanded specified securities under FAR

India’s government securities (GSec) market has grown to about ₹123.5 trillion (as of June 8), according to the Reserve Bank of India (RBI), making it one of the country’s most important financial markets. Most of the government’s borrowing is already funded by domestic investors such as banks, insurance companies, provident funds, and pension funds. Yet the government is making a fresh push to attract foreign investors, most recently by exempting them from taxes on interest income and capital gains from GSec and expanding the list of bonds eligible under the Fully Accessible Route (FAR).

But if India already has enough domestic buyers for its GSec, why does it want more foreign investors?

Who are the major holders in India’s GSec market?

According to the Ministry of Finance’s quarterly report on public debt management, commercial banks remain the single largest holders of the government’s dated securities, accounting for 34.31 per cent of the outstanding stock as of December 2025. Insurance companies held 25.89 per cent, while the RBI accounted for 14.52 per cent. Together, these three categories owned nearly three-fourths of the market. Foreign portfolio investors (FPIs) held only 2.96 per cent of outstanding government securities.

Why foreign investors matter

According to Kumar Rajagopalan, vice-president and country head (India) at global consultancy firm Dexian, GSec sit at the heart of the financial system with their yields serving as a benchmark for pricing loans and bonds across the economy.

“A deeper and more liquid government bond market improves pricing, and helps create a more efficient benchmark yield curve, which benefits capital markets more broadly,”he told Business news channel.

The first step, Rajagopalan said, is to build deeper, more diversified and globally integrated bond markets. “Foreign investors are anticipated to bring new ways of assessing risk, different investment horizons and trading models, which are expected to enhance liquidity and improve price discovery,” he added.

Finance ministry also said recently that a broader investor base can reduce dependence on a few large domestic institutions and make the market more resilient.

“More foreign investment in debt will help, amongst other things, in mitigating borrowing costs, balancing foreign flows vis-à-vis equity outflows and currency depreciation, and deepening debt markets,” Nehal Sampat, partner at Price Waterhouse & Co LLP, told Business Standard.

This is also the rationale behind India’s push for inclusion in global bond indices. Indian government bonds entered JPMorgan’s Government Bond Index-Emerging Markets in 2024 and were later included in FTSE Russell’s Emerging Markets Government Bond Index. Policymakers are now hoping to strengthen India’s case for inclusion in Bloomberg’s Global Aggregate Index. According to market estimates, inclusion in Bloomberg’s flagship benchmark could eventually attract around $25 billion of inflows.

Recent data suggests foreign investors are responding. According to data from the Clearing Corporation of India Ltd (CCIL), a key market infrastructure institution for India’s bond market, FPI holdings in GSec under the FAR route rose by ₹8,794.743 crore from ₹3.23 trillion on June 3 to ₹3.32 trillion on June 10, following the government’s tax exemption announcement and the RBI’s market-access measures.

What has been holding foreign investors back?

Market experts say the biggest hurdle is currency risk. “Investors continue to look at returns in dollar, euro, or yen terms and therefore face significant exposure to foreign exchange fluctuations irrespective of how attractive the yield on Indian bonds might appear,” Rajagopalan said.

This concern has become more pronounced as the rupee has faced pressure over the past year. The currency touched a record closing low of 96.86 against the US dollar on May 20 before recovering somewhat. It closed at 95.27 per dollar on Wednesday, June 10.

A foreign investor may earn an attractive yield on an Indian government bond, but a weakening rupee can erode a significant portion of those returns.

Taxation has also been a major obstacle so far. Sampat notes that two key impediments to broader participation and index inclusion have historically been restrictions on foreign ownership and taxation of interest income and capital gains. Until the June 5 amendment ordinance, foreign investors faced a 20 per cent withholding tax on interest income, a 30 per cent tax on short-term capital gains, and a 12.5 per cent long-term capital gains tax on government securities.

“As the returns on debt securities are comparatively lower, any tax incidence further accentuates the challenges,” he said.

Operational issues have been another concern. When Bloomberg Index Services Ltd (BISL) deferred the decision on including Indian government bonds in its Global Aggregate Index earlier this year, it cited settlement processes, registration requirements, post-trade tax procedures and market infrastructure considerations as areas that required further evaluation.

Barclays said the tax changes improve the attractiveness of India’s real yields and remove a structural barrier to bond index inclusion. SBI economists have similarly argued that the reforms could boost demand for government bonds, improve liquidity in longer-tenor securities and lower borrowing costs over time.

Opening the door, but not too wide

According to Rajagopalan, the country does not need foreign investors to dominate its government bond market. What it needs is a broader mix of investors that can improve liquidity and market efficiency while keeping domestic institutions at the centre. He says foreign ownership of around 8-15 per cent over the next decade would strike a reasonable balance.

Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not sharechart. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.

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