Analysts say LTCG tax cut may draw only modest foreign inflows amid larger market concerns

Foreign investors have withdrawn about $64 billion from Indian equities since October 2024, prompting calls to cut long-term capital gains tax (LTCG) for foreign portfolio investors (FIIs). Analysts at JM Financial project that scrapping the 12.5% LTCG could generate $3-5 billion of new inflows in fiscal year 2028, a modest increase compared with the recent outflows. The tax change would raise an average foreign investor’s annual dollar return by roughly 2.2 percentage points, but the brokerage describes it as a “second-order lever” alongside valuation levels and oil-price dynamics.

"Tax efficiency alone will not bring foreign capital back to India," said Nirav Karkera, Head of Research and Funds Manager at W by Groww. "Ultimately, tax reform can remove a reason for investors to stay away, but it cannot create a reason to invest. That conviction will have to come from earnings delivery, reasonable valuations and confidence in the rupee."

The Securities and Exchange Board of India (SEBI) has recommended removing LTCG for foreign investors, though the proposal is not binding and awaits government approval before the February budget. India’s current tax framework imposes a 20% short-term capital gains tax and a 12.5% LTCG on listed equities, with gains calculated in rupee terms, which can create “phantom gains” when the rupee depreciates.

Historical data analyzed by JM Financial suggest that crude-oil prices have a stronger correlation with FII flows than tax policy. Brent prices above $105 a barrel have coincided with net outflows, while prices below $90 have tended to neutralise or reverse the trend. Analysts argue that lower oil prices and sustained inflows over several months are needed before the FII cycle can be considered turned.

India’s equity valuations have softened, with the Nifty’s forward price-to-earnings multiple falling to 17.1 times. While lower valuations have historically supported inflows, recent market shocks have shown that valuation alone does not prevent large selloffs. The report notes that broader tax reforms could cost the treasury, as equity LTCG collections amounted to about ₹1.29 lakh crore in FY25, representing roughly 8% of direct tax collections.

Finance Minister Nirmala Sitharaman acknowledged the ongoing debate over LTCG and securities transaction tax, describing the discussion as “healthy.” If the tax relief is implemented and global conditions improve, analysts expect the first beneficiaries to be large-cap, FII-heavy sectors such as financials, energy, utilities and real estate.